Most Financials Dragged Down with Sub-Prime Lenders

Short term market movements are often the result of what I call “guilt by association” trading. Along with the dramatic decline in sub-prime mortgage lending stocks, there has been a huge drag on most financial services companies, even if there is little, if any, evidence that the meltdown in sub-prime is set to spill over into other areas.

One of the main reasons the market has been weak lately is because of the underperformance in the financial services sector, which is the largest segment of the S&P 500 index. While mortgage lenders should be tanking ( given that they lent money to people who could only afford the temporarily low monthly payments for their new homes, and not the higher payments that would take effect when the variable rate mortgages adjusted), should every consumer finance company be getting thrown out with the bath water?

Surely there will be some spillover, as there are always lenders with bad standard practices, but we’ve seen everything from credit card companies, to auto lenders, to bad debt collectors, to student loan companies (just to name a few) all get crushed in this environment. Unless you believe that every type of consumer lender had loose credit standards on par with the sub-prime mortgage lenders, there are opportunities everywhere to snap up cheap stocks. Wall Street is acting as if sub-prime loans are the majority of the loans out there, not a small minority. Investors can take advantage of that, and should.

There is an old saying that “the market can remain irrational far longer than you can remain solvent.” This is very true, and just because many financial stocks are trading at what I would consider unwarranted levels, it doesn’t mean they can’t go down further. You may even reach a point, like I did this week on one of my holdings, where the pain is so great (not really because of the drop in the stock price, but more because of the irrationality of the drop along with its magnitude) that you just throw in the towel like others are doing.

You know that doing so could very well mark the bottom and prove to be a horrible trading decision longer term, but in the short term it will help you psychologically to just not have to see the irrationality continue. Patience is the key for value investors, but sometimes it’s just too hard to be as patient as the market requires you to be. That is why the stock market is as much a psychological exercise as it is a quantitative one.

If you have some financial stocks, either in your portfolio, or on your watch list, that are getting unfairly punished recently, do your research and make sure the worries are relevant before selling the positions. If you can hold on (and even buy more) and not have it be a psychological drag on your trading mentality, you will likely be rewarded when all the dust settles, the truth comes out, and many of the current speculation is proved wrong.


Wall Street Journal Cover Story: One Year Later

Many of you may recall that I was featured on the front page of the Wall Street Journal last year for a story discussing the investment merits of Internet search giant Google (GOOG). In fact, some of you may have even discovered this blog directly as a result of that article. At the time I was writing a lot about the company and fortunately some Wall Street reporters took notice.

Whenever the article gets brought up to me, the most common question I get, perhaps quite predictably, is “Well, who was right?” Here we are one year since that article ran, so let’s reflect on how things have taken shape for the stock since then and see exactly who was right.

To summarize, the article was called “As Google Matures, Investors Take Closer Look at Its Risks.” In addition to myself, the other investor interviewed for the story was David Gordon, who also happens to be an avid stock market blogger (The Deipnosophist). Both of us were early investors in Google, but I decided to take my profits and move on to other stocks, whereas David was buying on dips and holding for the long term.

I had sold one chunk of Google at $467 in January of 2006, and followed that up by selling the rest of it in February around $400 per share. My logic was that I had a huge gain (after paying around $180 originally) and felt that many of the positive surprises surrounding Google’s search business had already been reflected in the stock. To diversify, the company began spending lots of money hiring people, investing in new services, as well as overseas expansion. To me, the easy money had been made and there was less certainty that the company’s other ventures would be as successful.

On the other hand, Mr. Gordon was confident that Google would be successful growing their model across other segments of the market. Despite the short term fluctuations in the stock, he did not sell any of his shares. Instead, he was quoted as saying “months from now, it will be at $600 to $800 a share and people will say, ‘My God, why didn’t I buy it back then?’ ”

As you can see from the chart below, Google has been very volatile over the last year. The shares dropped from $376 to $330, hit $450, dropped to $350, soared to more than $500, and now trade at $448 each.

So, who was right about Google? It really depends on how you define “right.” If you just look at the stock price since the article came out, Google is up 19% since then, giving David the nod. However, if you look at his prediction of $600 to $800 per share in a matter of months, though, he wasn’t. It’s been a year and the stock traded over $500 but only for a brief time.

From my perspective, I sold some stock at $467 and some at $400, for an average sale price of $417 per share. More than a year later the stock still only trades at $448 per share. It has only risen about 7 percent from my average sale price, during a time when the S&P 500 has risen by about 10 percent. For me, selling Google when I did paid off, as the stock has underperformed the market since then.

From David’s prospective, Google might not have hit $600 or $800 like he had hoped for, but he did not sell it, and the stock has risen nearly 20% in a year. In hindsight, it is true that his optimism was excessive, but the stock has gone up. We can hardly call that being wrong.

So, as much as some might want to crown a winner in what the Wall Street Journal called “A Tale of Two Shareholders,” we might just have to conclude that given our personal objectives, we were both right. To support that claim, I’d be willing to bet that having it to do all over again, we both would have done the exact same thing.