Knee Jerks Are Dangerous

 | Aug 02, 2013 | 2:00 PM EDT  | Comments
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Stock quotes in this article:

arii

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int

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hlf

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bp

One of the things I have always prided myself as a trader is being able to stay rational when emotions take over for others on a stock, sector or even the market itself.

So many times investors react to a one-time event to drive a stock way down past its intrinsic or fundamental value. A perfect recent case of this is the bull call option spreads I initiated when Herbalife (HLF) got driven down below $30 a share on the announcement that notable money manager Bill Ackman has taken a large short position on the equity. The company had been operating the same way for decades, so his comparison to their multi-level marketing model as a "Ponzi Scheme" simply did not hold water for me.

A bigger example was happened to the stock of BP (BP) after the gulf oil spill in 2010 when investors panicked over the biggest crude spill in North American history. Despite having scores of billions of assets to sell to pay any kind of settlement and being one of the largest U.K. companies, the stock was driven down into the $20s on fears of bankruptcy. Once it became evident that the accident was indeed tragic but not existentially threatening, the shares soon recovered into the low $40s.

Another such tragic event occurred outside of Quebec in July when a train loaded with oil broke of its docked position, rolled seven miles downhill, derailed and exploded. This event obliterated the downtown area of a small Canadian town and caused the death of some 60 people in one of the most horrid railroad accidents in recent memory. It also could mean the bankruptcy of the operator of the train. But this event also unfairly affected two equity positions I own and have added to this since this disaster occurred.

The first knee-jerk reaction of the market was to punish the stocks of tankcar manufacturers. This made no logical sense to me. The tankcars involved in the accident were decades old and met all the latest safety regulations. They were also the property of the rail operator. Long term, this horrible event might even be good for demand as railroads are forced to buy more modern tankcars or retrofit their existing tankcars as new safety regulations are legislated. I picked up more shares of American Railcar Industries (ARII), which I have profiled several times, for under $32 a share. The stock has since shot past $37 a share as rationality crept back into the market on the true impacts to the company's business and a solid earnings report.

An even more unfairly punished position of mine due to this tragic occurrence is World Fuel Services (INT), a large fuel logistics company. They owned the oil in the tankcars, which had been hired to deliver their product. Quebec has issued an order to have the company help pay for the cleanup. Although understandable from an emotional and political perspective, the order has little legal merit. It is akin to holding Amazon.com (AMZN) responsible for an accident committed by a truck owned and operated by UPS (UPS) while making a delivery of an Amazon order. Any significant cost is also liable to be covered by insurance. This has not prevented the market from knocking more than 10% off the company's market capitalization, despite a recent earnings report that beat on the top and the bottom lines. I added more at $35 a share yesterday.

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