Friday, March 28, 2008

Fighting the Emotional Response

I think one of the easiest traps to get into in this game is to watch your money fluctuate daily. On the one hand, you need to keep track of how things are performing, but on the other, it's an emotional roller coaster as things bounce up and down and all around.

In short, this week I wiped out my previous gains, and then some. I had made $600 on Wavefront (TSX-V:WEE) last week, when I sold for $3.18 a stock that I'd bought for $2.10. Since this appears to be a company with great growth potential for the future, I bought back in at $2.90. Now it's $2.70. I also jumped on to Bank of Montreal (TSX:BMO), a stock I've been considering for a while. Unfortunately, while waiting for my account with Questrade to open, I missed out on some of its best bargains, and the price has backed off a good 5% from where I bought it. And lastly, my holdings in First Majestic (TSX:FR) continue to languish, and despite a small rally, I'm still down a couple hundred dollars on them.

So the problem I'm having is this - I'm confident in all of these companies. I believe they're great long term holdings. But in the short term, I'm watching my market value wither, and I can't help that gut response "'ll be cheaper later." I think there are times to sell losers - when there's reason to believe that the market is near the top of a cycle, or if new information is comes out that doesn't look good. But this isn't one of those situations. The market is at least mid-way down, and I personally think it's closer to the bottom than that, so selling even stock that largely moves with the index - BMO - seems to pose an equal risk to holding.

And WEE and FR could be poised for a breakout year. WEE's technology is now market ready, and they made a major sale to a Texas oil company last week, so I see no reason to believe more won't be on their heels. FR's production is way up, and it would not be unreasonable to expect them to start posting profits this year. There's a Warren Buffett quote to the effect that stocks are the only thing that people start buying as they get more expensive. I'd rather be in now than wait for the next announcement.

So, I fight the emotional response. It doesn't make sense to sell solid companies just because they're declining in the short term. But it's sure a tough urge to fight.

Wednesday, March 19, 2008

Ups and Downs

I have concluded that markets are psychotic. I suppose this was obvious before, but this is the first time I've had money in more volatile investments where it becomes really obvious.

So, my three holdings up to today were First Majestic Silver (FR), Wavefront Energy (WEE), and iShares Gold Index Fund (XGD). Yesterday, the market was expecting the US Fed to cut interest rates by 100 basis points, and it only did 75. This seems to have caused some kind of major overcorrection in gold prices, and XGD has dropped significantly over the past couple of days. FR has been going downwards ever since it made a private placement a couple weeks ago, and today dropped below 4.60.

On the flip side, WEE announced a major sale of its technology to a Texas oil company, and went from 2.59 at open to 3.56 at its peak today. It's now bouncing between 3.22 and 3.30. While this one was great for me - it hit my sell price of 3.18 around noon and leaving me with a $600 profit on a $1600 investment - in just two weeks - I think that perhaps this is my greatest confirmation of market psychosis. None of the news releases that I found seemed to indicate the value of the deal, but I'm having a hard time picturing it increasing the company's worth by 50%. More if you note that it also posted some hefty gains yesterday.

So here's what I'm trying to figure out - when do you bail on a losing investment. I'm still confident that FR will come back once the market's had a chance to digest 8.5 million shares, but XGD I'm iffy on. I bought it based on some discussions that while gold was in record dollar territory, it was a long way off its inflation adjusted highs. However, because gold is so high, I'm not confident that holding it will come back if I hold onto it in the longer term.

I'm having a hard time pegging exactly what makes gold tick. I would have thought a rate drop of 0.75% would have been good news for gold. But it's dropped a lot in the wake of it. So I've got some reading to do, and if I actually have any readers, would appreciate anyone's thoughts on where gold is going from here.

Friday, March 14, 2008

Banks? Good Value?

I'm currently thinking that, despite all the market turmoil at the moment, that it really might not be such a bad time to be starting out in the investment world. I mean, the market has fallen significantly, so there should be some good buys around, if only I can accurately gauge when things are near the bottom.

So I'm looking at the banks, which have been very hard hit by this credit crisis. Bank of Montreal (TSX.BMO) is off 45% from its 52 week high, as is CIBC (TSX.CM). The much better performing ScotiaBank (TSX.BNS) and Toronto Dominion (TSX.TD) are down around 20% from their highs. Price-Earnings ratios for most are in the 10-12 range - CIBC is the exception, with a PE of 22. The historical average for PE is 16, so it's looking to me like there just might be a bargain to be had. Nothing I've read has suggested that these banks might be going under, so when the recovery comes, they should go up quite a bit. Right?

The problem with using PE to base your buying decisions is that it relies on earnings remaining fairly constant. Right now, the professionals seem to be saying that bank earnings are unpredictable, and it would be a good idea to instead look at price-book value ratio. One article I was reading suggested that they're still overvalued using this ratio, when compared to other market troughs.

So I'm not sure what to think. I'm waiting until I get an account open with a lower-cost broker - I decided on Questrade - before I buy anything else, since the TD Waterhouse commissions really hurt potential profits, and do nothing but increase the pain on losses. But I think that if the banks seem to have flattened out by the time that's complete next week, that I'll buy into one of them, I'm currently leaning towards BMO, but I need to look into it further.

Thursday, March 6, 2008

On Private Placements and Warrants

Well, just last week I started buying into some stocks, two specifically, both ones that had been discussed in my investment class, and, after I'd done some more research, appeared to be good buys. One is First Majestic Silver Corp (TSX:FR), a small silver mining company that is rapidly developing mines in Mexico. The other is Wavefront Energy and Environmental Services (TSX-V:WEE), a company that has developped a patented technology for better distributing fluid injected underground - the major upshot of which is being able to extract significantly more oil from depleted wells.

Yesterday, both of them made announcements that had to do with private placements, and warrants, so now seems as good a time as any to share what I've learned about those.

What is a private placement?
Since this blog is about being a beginner in the investment world, and I'm expecting any readers (should there be any) to also be beginners, some explanation is in order.

Essentially what happens is that new shares are created and sold to raise capital. It's not a public offering, you have to be invited to get in on it, and usually that only happens to people and companies with deep pockets. Additionally, most private placements include warrants.

So, then, what's a warrant?
A warrant is a type of options, and from the holder's perspective is a lot like a call. They allow the warrant holder to buy a share at a fixed price for a fixed amount of time. The difference - aside from warrants being free as part of a placement - is usually the length of time, and the source of the shares. When you buy a call on the options market, usually the longest ones expire in 6 months, while warrants are typically good for 1-3 years. Then, when you exercise a call, you are just buying existing shares from someone else, and they lose money on the deal, whereas if you exercise a warrant, new shares are created by the company and sold to you...meaning that even though you're probably buying them at below market value, the company still raises extra capital when they're exercised.

Some warrants are traded on the markets as well.

Make sense?

And what happenned yesterday?
Yesterday, First Majestic announced that they were entering into a private placement with several underwrites, including CIBC World Markets, Blackmont Capital, Cormark Securities, and GMP Securities. They will sell those two companies a total of 8.5 million shares at $5.35 per share. One warrant will be issued for every 2 shares, with a strike price of $7, and good for 2 years. Before this announcement, FR had been trading at $5.65...great news for me as I'd bought it last week for $5.10.

So what's it mean...basically it seems to mean that I'm not rich enough to make the serious money. More specifically, what it means in the short term is that the stock will likely decline...that's a lot of extra shares out there diluting the value of the company. I'm not sure how low it will go, it opened this moring at $5.14, and has hovered around there for a few hours so far. Only one trade was below my own buy in, at $5.07, so I may be alright. Also, the effects of warrants are interesting. In my class, we've looked at a couple of stocks with outstanding warrants, and what seems to happen is that the big players who hold the warrants start shorting the stock when it hits their strike price, causing the stock to drop, because they have insurance that they won't lose money on the deal if other trading manages to counteract the short. Since the strike price is $7, this would still be a significant profit for me, so I'm not all that hard done by. However, when I got into FR, I was expecting it to be a quick turnaround...maybe a month or so, as it was significantly undervalued and looked poised for a breakout. Now I'm expecting to have to hold for several months to see the gains I wanted.

With Wavefront, the event was almost the exact opposite. Wavefront had previously concluded a private placement, and has outstanding warrants as a result. Their announcement was that because their 20 day, volume weighted average closing price was above $1.50/share, all warrants - which had previously had expiry dates of either Dec. 24, 2008, or January 31, 2009 - had to be exercised within 30 days.

I'm new at this, so exactly what this one means required a bit of research. Essentially, it's a good thing, because removes the warrants from circulation, which, as previously discussed, allows big players to play with the stock price with no risk. Share dilution - the new shares created when existing warrants are exercised - already shows up on the financial statements, so the share price should already be taking into account the existence of these shares. So, the effect of this should be negligible or good. And today's results seem to confirm my understanding, as the stock is continuing to slowly increase.

On the chart below, you can see the overnight effects of this news:

Wednesday, March 5, 2008

Picking a Discount Broker

I've been a TD customer since I was a child, and have had a discount brokerage account with TD Waterhouse since I first bought mutual funds 7 years ago. Until now, I'd only ever used that account to trade in TD mutual funds, and saw no commission. Now that I'm branching out, I've quickly realised that for investors with less than $50k, and fewer than 30 trades last quarter, it costs a wopping $29 per trade. Since I'm starting out small with trades around $2000, that means my stocks have to go up 3% just for me to break even, clearly not an acceptable situation.

So I'm in the market for a new broker. As it turns out, picking a broker is like picking a long distance plan - everyone has a completely different fee structure, so you have to guess at your useage in order to pick the cheapest. I've laid out the prices I expect to pay as a beginner in the spreadsheet below. For other types of investors, there's also a summary over at the Stingy Investor.

If you find the spreadsheet confusing, you're not the only one. It's my attempt to present the complicated fee structures as consistently as possible. Basically, unless you meet the discount threshold, you will never pay less than the minimum trade cost.

Price isn't everything, research tools are also important, so I'm going to have to give some thought to that as well, before making a decision

Saturday, March 1, 2008

Types of Investors

From what I understand, there's three broad groups of investors in the market:

Long-term Investors
These sorts look at the fundamentals of a holding and buy for the long term, weathering out the ups and downs in order to see long term gains. Most consumers seem to long term investors, and it's certainly the mentality that's pushed by the financial services industry. The good thing is that over long periods of time, stocks and other investments do rise, so for things like retirement funds, long-term investing does work.

The downside is that because long-term investors hold on through the down cycle, they have to see higher returns on the up side in order to arrive at the same place as others. In recessions, markets usually lose around 30% of their value, and have lost as much as 50%, so when things recover, long term investors need to see a gain of 42%, and as much as 100% just to get back where they started. Another problem, particularly with small individual investors, is the panic psychology...many of us, and I include myself here, will panic when we've lost 10%-20%, and end up selling off, and then missing the recovery. This has been one of my biggest problems in my past dealings with mutual funds, and something I'm hoping to avoid going forward.

Traders -
Traders keep an active watch on the market, look for bargains, and then sell when they've seen the return they're looking for. Some traders also look for overpriced stocks to sell short, and again, cover them when they've seen their target return. From what I know, this involves taking into account the fundamentals of a company, as well as technical analysis on how it's trading. I'll discuss what I've learned about analysis in another post.

Speculators -
These are your high risk, high reward types. There's a lot of grey space between trading and speculation, but basically what makes a speculator different is that they completely discount the fundamentals of a company, and focus entirely on short term movements in the market.

Myself, I'm aiming to be more of a trader than anything else. Shorter term profits, hopefully, but still keep track of the fundamentals of a company, so if it doesn't go up as expected, I can confidently hang on until it does.