Stick to Your Investment Philosophy

 | Feb 21, 2014 | 2:00 PM EST  | Comments
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One of the best pieces of investing advice I have received in my life is don't embrace investment philosophies that run counter to your core personality.

I am a born skeptic, which makes me an absolutely terrible momentum investor. I marvel that Facebook (FB) can pay $16 billion for a company with no revenues and 55 employees and actually end up going up in the market on the news.

This is a double-edge sword. It means I almost always miss out on the meteoric rises of the Tesla Motors (TSLA) and Amazons (AMZN) of the world. On the bright side, when the internet boom busted nary a share of Webvan, Pets.com or Cisco Systems (CSCO) at over 100x earnings were in my portfolio.

Being a skeptic I also always distrust the consensus as it is rarely right. Each year, it seems the 'consensus' forecast for equities calls for a gain of 5% to 10%.  It is a rare year when the market actually produces a gain in that range.

This natural tendency to not accept the collective wisdom of others has made me a successful contrarian investor over the years. I have found that the worst performers in the market in any given year can be and quite usually are among the best performers in the next year. Look at gold and silver miners this year or solar stocks in 2013 after coming off a dismal 2012.

This bent also leads to many opportunities in special situations. Take the rail derailment tragedy that firebombed a small town outside Quebec during the summer, killing some 50 people. Investors abandoned the stocks of the tank car manufacturer American Railcar (ARII) as well as World Fuel Services (INT) whose fuel was being transported. Neither company had anything to do with the derailment, or the resulting explosion.

As I stated in early August , this presented a great buying opportunity. Both stocks are up substantially since then and are still in my portfolio. I believe another special situation is starting to present itself among the companies in the mortgage servicer sector.

I made quite a bit of money going long these stocks last the summer. One of the consequences of Dodd-Frank is that banks have to hold additional capital against certain assets such as mortgage servicing rights. This has made the area much less profitable for banks. As a predictable result, banks have sold off these rights en masse to mortgage servicers. 

This caused mortgage servicing stocks like Ocwen Financial (OCN) and Walter Investment Corporation (WAC) to soar last year. The stocks have cratered lately as state regulators have grown concerned that these firms have grown too fast and customers are not being serviced properly.

This situation where one part of government causes something which leads another part of government to attack the natural consequences of the new regulations would be comical if it was not causing such business certainty. This is a key driver to the consistent tepid job growth in the weakest postwar economic recovery on record.

It also creates a longer-term investment opportunity. I think it is safe to say that Dodd-Frank is not going to be revoked or rewritten in a major way in the foreseeable future. Therefore, these issues on a state level have a high probability of being worked through toward some sort of livable solution.

I started to nibble at the sector Thursday by picking up some shares of Walter Investment Corporation at $26 a share. It seems to be less of a target of state regulators than Ocwen Financial, but has sold off over 40% from recent highs nonetheless. The stock goes for just under 5x forward earnings. The company should also be bolstered when mortgage originations pick up again after this horrid winter across most of the country subsides.

I am going to average in on dips as the negative sentiment may take a while to lift on the sector, but brighter days should return in the near future. They usually do.

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