Reviewing Some Stinkers

 | Sep 23, 2011 | 12:30 PM EDT
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I have spent some time this week looking over my portfolios to see what I want to add to when I decide the time is right. As a deep value investor, I have some pretty good winners and a few real stinkers. Today, I want to address the stinkers since they are the ones I get the most email and questions about. Nobody gets them all right -- but when I get them wrong, I tend to do so in a big way.

The first one is Shore Bancshares (SHBI). It was the very first bank stock I started buying as part of the trade of the decade. When I made my first purchase, the bans was trading below book value, had a strong local franchise and loan losses were reasonable and lower than many other banks. But since that time, things have gotten steadily worse for the bank.

I am not sure how I got this one as wrong as I did, but Shore Bancshares seems to have collected all the bad loans on the Maryland's Eastern shore. Since I first suggested and purchased the stock, noncurrent loans have more than doubled from $23 million to more than $49 million. Profits have dried up and the bank is now losing money, year to date, through the end of June. Net charge-offs have gone from less than 1% of total loans to 2.82%. Non-performing loans as a percentage of all loans have gone from less than 1% to 2.8%. Real estate owned has grown from less than $2 million to almost $8 million. If it could go wrong, it has gone wrong for this bank so far.

The company has a 50% exposure to commercial real estate and construction loans in its portfolio. That will continue to be a problem until the local economy strengthens. Their service area is more small towns and rural areas and these are not seeing any strong economic growth and there are not financial center urban locations to serve as a source of growth for the bank. Loan demand remains very weak in most if its marketplace and now it will probably seem some interest-rate margin squeezes from the Fed's Operation Twist program.

However, I am not going to sell my shares in the bank. I think that management has deep ties in their local markets and will manage to ride out the storm. However I do not see any break in the clouds for this bank I am not going to add to my stake anytime soon either. I need to see some improvement in the loan losses and non-accrual loans before I can add to my position with any confidence. The stock has gotten cheaper to be sure, but it has not gotten safer in my opinion.

Another one of my "oh wow, I was a tad early here" stocks is Avatar Holdings (AVTR). The poster child of the real-estate bust has seen its stock go south as development and sales opportunities in Florida and Arizona have disappeared on the last three years. Business is not getting any better for the company. It lost $26 million last quarter and has taken on some additional debt since I first bought the stock. The Poinciana Parkway project looks less likely to actually happen and that will be a hit for the company as well. It can be generously described as an ugly situation.

So for this one I am going to step up and add to my position. The company can be liquidated for more than its market value -- even with healthy discounts to its land holdings. It has $146 million of unrestricted cash on hand, which it has been using to buy back debt at a discount. Someday, sunshine will come back into vogue and when it does, this company should return to profitability. The stock is for patient investors only, but I believe Avatar will end up being very rewarding within my decade-long time frame.

Asset-based value investing is not always pretty and I am not always right. However, with enough patience and discipline, it does pay off over time.

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