Active Investing and 33% return, lucky or correct strategy?

[DesertCat]

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You know that Bulletin Board stocks are not required to submit audited financials like NASDAQ and NYSE stocks do, right? They might be telling the truth or they might be lying.


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Many OTC & pink sheet stocks have audited financials. Sometimes they are even current on their filings with the SEC. Sometimes they are only temporarily behind. One of my biggest winners refused to file with the SEC or seek a listing for very good reason. Bayou Steel had emerged from bankruptcy with a ton of NOL's that it wanted to shield, and it actively discouraged trading of the stock because any large turnover of shareholders would cause the IRS to disallow those NOLS. But it still had audited financials, which were available over it's web site. It was eventually bought by a private equity firm at a 75% premium to it's trading price.

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Do you search the backgrounds of the officers and board of directors? Do you search trade journals for mention of their products? Do you consult experts in the field to verify that their claims seem plausible? Do you maybe even go so far as to visit the company and make sure it's for real? These are all things we do before we play a BB and we usually end up shorting it. Most BB companies will never earn a dime and a lot of them are outright scams.

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In the case of Bayou Steel I did little of that. I read their financials and their old SEC financials, which verified it was a real company. I read some news stories on it via Googe that verified it was still up and running. Then I called the CFO, which verified he was breathing. Then I bought a ton. My biggest risk with that investment wasn't fraud, it was the future direction of steel pricing.

There is a ton of value on the OTC and pinksheets. My experience is that the scams aren't that prevalent. You can usually smell a fraud as soon as you read one of their ridiculous press releases. I seldom have to go to extraordinary lengths to validate their businesses. Your advice to be wary is true, but if you want to be a value investor, this is where the most value lies.

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If you've been playing big movers and been getting out with good profits, then I would say a part of your results are luck. Usually when these things fall, they go quickly. If you are quick and not too greedy, it can be a profitable strategy. Just don't kid yourself into believing you're "investing" in the next Microsoft.

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I've been investing in OTC stocks for five years, and my results have been consistent with OP's. I can't say he's skilled or lucky, I don't know how he does his research and how well he understands value (like how to avoid value traps). But my experience is that if he's skilled and works hard at it, very good results are sustainable in this space for a small portfolio.

OTC and pink sheet stocks are big part of the reason why Warren Buffett guaranteed he could earn 50% annual returns with a $1M portfolio. It's the most inefficient, dirty, stinky, corner of the market.

[krishan]

Great post DC.

So excluding OTC Magic formula stocks might not have been the savvy move I thought it was? [img]/images/graemlins/smile.gif[/img]

Krishan

[hawk59]

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I did a lot of research on the companies before
I invested, but still assumed a lot of risk.

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What kind of research? Did you just look them up on Yahoo and believe the numbers there? Did you just read the press releases put out by the companies and believe them? You know that Bulletin Board stocks are not required to submit audited financials like NASDAQ and NYSE stocks do, right? They might be telling the truth or they might be lying.

Do you search the backgrounds of the officers and board of directors? Do you search trade journals for mention of their products? Do you consult experts in the field to verify that their claims seem plausible? Do you maybe even go so far as to visit the company and make sure it's for real? These are all things we do before we play a BB and we usually end up shorting it. Most BB companies will never earn a dime and a lot of them are outright scams. If you've been playing big movers and been getting out with good profits, then I would say a part of your results are luck. Usually when these things fall, they go quickly. If you are quick and not too greedy, it can be a profitable strategy. Just don't kid yourself into believing you're "investing" in the next Microsoft.

It might be eye-opening to pull up the charts of the stocks you traded a year ago and see what they've done since.

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You're overestimating the amount of research that needs to be done for most stocks. A good rule of thumb is that the less research you need to go to get comfortable with something the better of an investment it probably is.

[NajdorfDefense]

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I did a lot of research on the companies before
I invested, but still assumed a lot of risk.

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What kind of research? ...Do you search the backgrounds of the officers and board of directors? Do you search trade journals for mention of their products? Do you consult experts in the field to verify that their claims seem plausible? Do you maybe even go so far as to visit the company and make sure it's for real? These are all things we do before we play a BB and we usually end up shorting it. Most BB companies will never earn a dime and a lot of them are outright scams. If you've been playing big movers and been getting out with good profits, then I would say a part of your results are luck. Usually when these things fall, they go quickly. If you are quick and not too greedy, it can be a profitable strategy. Just don't kid yourself into believing you're "investing" in the next Microsoft.

It might be eye-opening to pull up the charts of the stocks you traded a year ago and see what they've done since.

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You're overestimating the amount of research that needs to be done for most stocks. A good rule of thumb is that the less research you need to go to get comfortable with something the better of an investment it probably is.

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I agree. Here is the amount of 'research' I did on UST this year before investing at end of Feb at 38 and again at 41:

"5.5% dividend yield. Trading at $41.50. Stock is down 17% in 12 months, only up 2% this year. $7bn company. PE of 13, earnings due 4/26. Traded as high as $54.84 last year. Divs growing at 5% per year.

What alerted me to this company was the record insider buying last month of $680k, not a huge amount, but anytime you see 'record insider buying' esp from an old-school firm like this, you sit up and take notice -- to me it's like the proverbial bell-ringing.

David Dreman is one of the largest holders of UST.

QoQ earnings went from 77 to 82 cents, estimates were 82.3 cents.
5-yr earnings growth of 3% - not very exciting.
I know - you're thinking 'tobacco is a shrinking market,' well, that's true for cigarettes, smokeless tobacco has been growing each year as people stop smoking but need their nicotine fix. Very popular with the NASCAR crowd, needless to say.

Analysts hate it - 3 buys, 3 neutrals and 3 Sells! Three sells [including GS and Pru and Citi]

Net income has gone from -271 to 319 to 531 to 535mm past 4 years.
Cash flow fro Ops has been $560mm past two years. Cap Ex is de minimus, averaging about $70mm per year last 3 years. Last year paid out $361mm in dividends. Paid off $300mm of LT-debt last year.
Net Sales have gone from 1.64 to 1.69 to 1.78 to $1.81 bn in 4 years. Interest expense is falling, and they have ST-debt.

Wine business - growing at 13% a year and is now 15% of revenues, an overlooked double-digit grower. Cigar business is tiny, but growing at 15% a year, not really worth much.

Possible catalyst -- Altria and RJR may starat a bidding war for Conwood Co to gain entrance to the fast-growing smokeless market, according to Citigroup. Conwood, which is private, may fetch up to 4x Sales and they control about 25% of the market. Smokeless is growing at about 5% per year.

UST controls about 65% of the market.

Altria CEO Camilleri commented in January that he was interested in joining that market, 'You can clearly expect quite a lot of activity in the coming months on that front. ' he said to analysts.

Value investors such as US Trust have commented on the breakup potential as well - or ability to cut costs and save on dividends if UST is acquired.

I figure, at worst my downside is limited, and I'm getting paid 6% or so on my original purchases to wait. Someone is going to snap these guys up -- although maybe not for a long time -- and I'm happy to buy the leader in a growing category at these prices. Plus, it is a very defensive play, obviously, in a recession, people buy more chew."

You don't need to do 10 hours of work a week on every idea to find a good one; some more, and some less.
Some just jump out at you - pattern recognition. Although, the more complex the idea, the longer and harder it is to estimate/model/value. UST is relatively simple.

[wiseheart]

Thanks for the clarifications. Obviously, I agree
with DesertCat that a skilled trader can find good
value on OTCBB stocks. I don't claim to be skilled,
just that I did work to achieve what I got.

Also, to clarify, when I said 10 Hours, I spent about
2 1/2 hours once a week researching a stock for a couple
of weeks. Sometimes I spent as little as 3 hours getting
all the details and news of the stock read before buying
without any real indepth research, I think this was the
case with STKL.

Just to conclude with this thread, I wanted to make a
point that it is possible to make a good return with active
investing, with some work (but not a whole lot)
Mr. Now was attacked for saying he could achieve 20%
returns annually. I think these returns are achievable
On Average . Regardless of how my return is in
the coming year, I plan to come back and report on my
results.