With the day after Christmas falling on a Friday, it is a perfect time to reflect on 2014 and what I learned during the year. Revisiting successes, and more importantly failures, during the years, provides information that makes you a better investor going forward. It seems that no matter how long I do this, and it has been a long time now, there is more to learn. Should you fail to spend the time learning, the market will frequently decide its needs to fill the professorial reality, and that can be brutal.
This year's first lesson has to do with resource and commodity stocks, most notably oil and gas. This was the first time in my career that I got caught long resource names before the price collapse. I had owned cheap oil and gas stocks, and even a few miners along the way, but in the past, I was always a buyer after the price of the resource had fallen. This is the first time I was buying stocks that appeared cheap on an asset basis, while the price of the commodity was still high. I expected cheap energy-related stocks and iron ore stock to recover the way they always have in the past, to reflect the value of the underlying assets. I made a huge mistake.
I used normal scenarios of pricing to make worst-case assumptions and I didn't test for the really stupid price. Of course, markets have headed down to the stupid price, and the margin of safety I thought I found in stocks like Hercules Offshore (HERO) and Swift Energy (SFY) began to evaporate. When I reworked the numbers as oil prices began to get serious about sliding, I found that if oil prices stayed under $60 per barrel for an extended period of time, these companies would have serious financial issues. This failure to test for the unthinkable extreme has turned what should have been a great year into an OK year.
In response to the inevitable question, after much chain smoking and serial cursing my decision on these stocks, was to hold them. None of us know where oil will price will actually go next year. If T. Boone Pickens ends up being right, and we get back to $100 in a year or so, I could still end up profiting handsomely. That's only 25% or less on my average four-year to five-year time frames, so I will hold these though the pain. Due to the fading margin of safety, I will not (as I usually would after a decline) add to those stocks that fail the unthinkable price stress test.
It is worth mentioning that after I tested everything for extreme conditions, I was able to confidently double down on those that passed. Those include Noble (NE) and WPX Energy (WPX), as well as new names such as Gulfmark Offshore (GLF) and Tidewater (TDW). That is actually working out pretty well so far.
Lesson number two this year is that when a stock passes the entire test, just buy it. I have three examples of this in 2014, two that worked for me and one that was an "oops". In the past few years, I had picked up a stake in two net-net stocks that worked out pretty well for me this year. There was nothing special or attractive about either. I didn't really like either of the businesses: a lower-level air freight delivery service heavily dependent on one contract, and a protective garments company that had just lost a major lawsuit in Brazil. I stayed with numbers, in spite what I thought at the time were unattractive businesses. Thanks to falling fuel prices and an Ebola scare. I ended up selling both Air T (AIRT) and Lakeland Industries (LAKE) for about several times of what I paid for them.
The" oops" was Peerless Systems (PRLS). It too was selling for less than net current asset value, and by the rules, I should have bought the stock. Their imaging solutions licensing business was pretty much a wind-down sort of thing, and the new CEO had designs on turning it into more of a closed-end fund type situation. I wasn't crazy about the idea. Its initial investment in ModusLink (MLNK) was not exactly awe-inspiring to me. I overrode the numbers and passed on the stock. The stock was then about $3.50 per share, and I never revisited the idea.
In September, Peerless announced it was buying 80% of Deer Valley Corporation, a manufactured homes company in the Southeast, and that gave the stock a pretty good bump of about 50% or so. Yesterday, it was announced that Mobius Acquisition made an offer for Peerless itself at $7 per share, more than doubled what I could have paid for the stock.
Along with generous amounts of coffee, I have spilled a lot of my 2014 reflection onto my trusty legal, but I have already run too long today. I will share the rest next week. I think some of it is valuable, and will help us all make more money in 2015.
For now, I leave you with two rules. First, always test for the ridiculous and seemingly impossible conditions, because they will most certainly occur at some point. Second, trust the numbers. Odds are they are smarter than we are.