I struggle in markets like this one, or more specifically, the one a couple of weeks back before this current hiccup. In the latter innings of a bull run, valuations, by definition, become more and more stretched from the conservative projection of the fundamentals. Another way of saying this – or, perhaps its implication – is that projected returns decrease with each uptick. It is during this part of the cycle that I find myself selling, as the value to cash as an option on cheaper prices (and hence, again, greater returns) in the future increases.
But as we are human, we remain on the lookout to undertake prosperous endeavors even as the market, in general, begins to froth. Moreover, it is a doctrine of the value investing catechism that the market doesn’t matter, only individual stocks do (I do concur with this dictum but caution against a dogmatic adherence…see 2008). And so we look for stocks to buy.
The problem I have found in my hunts at times like these is that the good companies are simply too pricey to be investable. Not a quitter, I keep looking and eventually do usually find some apparent bargains. However, they tend to be in areas that are not as fundamentally sound, which can be okay if we are careful, and they tend to be in areas where I lack a historical track record, the proverbial necessary experience. Alas, how does one gain experience… by experiencing, of course!
The area today that I am seeking to experience is natural gas. This has been a trap for several years for a sound fundamental reason – there has been a glut of the stuff. I’ve read several pitches over these trap years predicting well caps and the subsequent rebound in pricing, and this – as we all know, has yet to occur. But, what cannot continue on forever won’t; and there will come a day when this most useful of commodities will provide its owners with adequate remuneration again. The question obviously is when. As I have avoided the natgas trap so far (and have very little else to buy with my growing cash hoard), my gumption is up to catch this knife. I am dipping my toe in betting that the ‘when’ is within three years or so, acknowledging full well that a zero could be added to this three, thereby blowing up our returns.
To the title of this piece, I am trying out natural gas (more specifically, a couple or three well-run companies in the complex). And I will most certainly learn something in so doing. Here is what have I learned from my previous ‘try-outs’ that should prove useful this time around:
- Don’t overbet. Annihilation risk – or an unacceptably high amount of capital destruction – in situations where you are not expert is reckless, foolish, and can set back good thinking for years. We all must provide our own answer to the question of how much is too much. I offer 3% positions with a maximum exposure of 10% or thereabouts to the complex are levels that allow me to still sleep at nights.
- Watch the balances sheets. This is the first cousin to annihilation risk, at the individual security level. Some companies, we know, just aren’t going to go broke. They are clearly to be preferred – downside protection to be favored over multi-bagger dreaming.
- Revisit the theses more periodically than usual and, more importantly, do not be stubborn to admit you are wrong. Investing is a learning game, and foraying into new areas even more so. It becomes obvious, then, that you should engage more frequently with those investments that you have more to learn about…so as to learn more about them! The second part to this lesson is, perhaps, more critical. Fundamentals-based value investing requires being unpopular with the crowd a great deal of the time. A stubborn streak is, therefore, indispensable, to stand down the crowd’s jeers, wait for the turn in a sound business and/or the turn in the crowd’s fickle mood. That being said, fundamentals investing is, at its core, rational. Keynes said it best, “When the facts change, I change my mind. What do you do, sir?” In areas where we are not yet experienced, we must be leery of our stubborn streak. At the outset is the confession we have more to learn in these areas; as the learnings come in and the facts change, be honest with yourself even, and especially, if they come in to your disliking.
Good investing and good learning to all. And here’s rooting for the return on $6 natural gas!
Eric Houssels is the co-founder and managing member of Houssels Capital Management, LLC, a money management firm based in Las Vegas, NV. The firm focuses on investments in the stocks of publicly-traded companies of all capitalizations that possess, preferably, significant earnings power or, alternatively, assets that can be (re)deployed to achieve significant earnings power and are trading at reasonable valuations. Houssels Capital Management was founded in 2000.