Wednesday, November 29, 2006

What should I buy?

Over the last few weeks, I have not been able to do much stock analysis. I've unfortunately been very busy at my full-time job as a software engineer. In my defense, there hasn't really been much to do as the unusual bullishness of the market has priced me out of a lot of opportunities. The gambler in me wanted to buy puts on QQQQ last week, but the chicken in me set the limit order too low to execute before Monday's fall. Such is life... It also doesn't help that APOL, OC, LM, WU, and USG have all gone up from when I first started looking at them.

I expect that I will be relatively busy until after the holidays. For my occasional readers, here's what to expect from me before the new years. I'll post a book review with key take-aways from Phil Fisher's Common Stocks and Uncommon Profits. Then I'll polish up my DCF calculator and publish it for everyone to use. I use this DCF calculator as a preliminary screen of stocks that have caught my eye. By publishing the tool, I'll be able to keep a history of what stocks are being screened by my well-informed readers. Hopefully I can get some good ideas from you =). Finally, I would like to work on providing podcasts of relevant earnings calls for my readers. I spend about an hour commuting every day, so podcasts would be very helpful for me to keep an eye on my basket of stocks.

As an update, Western Union and USG are two opportunities that I would jump on if the price ever came down to my current target buy-below prices of $21 and $47 respectively. In order to lock-in these prices, I sold Feb 07 puts on both stocks. Before Thanksgiving, I sold a Feb 07 $22.50 strike WU put contract for $1.10 per share. Because of Monday's drop, I am sitting on a loss with this position. I also sold a Feb 07 $47.50 strike USG put contract for $1.75 a share. For a good description on my view of writing puts, please refer to Million Dollar Countdown's post on 10 ways to minimize risk when selling put options.

In the blogosphere, I've found two other articles singing praises for USG. Whitney Tilson, a former Motley Fool columnist and now fund manager calls USG, the little stock that beats the market, while Evan Vanderveer likes USG the best. It's nice to be in good company. For those interested in Owens Corning, I would take a look at USG first. The situations are similar, but there are more gurus invested along side you with USG.

I am currently looking at increasing my position in First American Corporation (FAF), which has retreated about 5% below my original cost basis. It reported tentative third quarter results that missed analyst's estimates and may need to re-state its financial statements due to possible option-backdating. Since options back-dating usually does not impact cash flows, I view this as a temporary issue. I will need to review this past quarter's results before I make a move. I'm also considering increasing my position in Home Depot (HD). This week I made two small mechanical purchases of Advance America Cash Centers (AEA) and John B Sanfilippo and Son (JBSS). Should I buy more? I will need to do more due diligence before I increase the size of these small positions.

This blog doesn't really have that many readers, but I'd be interested in your opinions. What do you think I should buy? In times like these when undervalued stocks are hard to find, we really need to band together and share our results.

Good luck and be careful out there. The bulls are in control, but there are still a lot of uncertainties that everyone seems to have forgotten about.

Saturday, November 11, 2006

Quick Valuation - Owens Corning (OC)

Owens Corning recently emerged from Chapter 11 with a rights offering backstopped at $30 a share. Owens Corning is a leader in the building materials industry, supplying glass fibre and insulation products for residential and commercial applications. Over the last two weeks the shares traded as low as $26 dollars and are now currently trading close to $29. I'm interested in this company because it's a situation very similar to that of USG's. I'm hoping to apply what I learned from the USG valuation to value Owens Corning.

Looking at the company's most recent 10-Q balance sheet, the situation looks misleadingly bleak. It had over $8 billion in shareholder equity deficit. This number however is most likely not up-to-date. I think a majority of the deficit has been nullified with the recent re-structuring: cancellation of the old shares, creation of the new shares, rights offering of new shares to creditors, bond holders, etc, and creation of the 524g Trust. If I assume all the $13.5 billion "liabilities under compromise" are replaced by the new liabilities listed in the 10-Qs restructuring notes, I get a company that has a slight shareholder equity deficit. I am not sure if my calculations are correct, so I have contacted investor relations to clarify.

The old shares of the company are now cancelled. Shareholders receive rights to buy the new stock at $45.25 dollars. This price is far from the current price, so I will not factor this into my calculation of the current number of new shares outstanding. Reading through the 10-Q, there are 27 million shares given to bondholders, 72.9 million share rights offering, 3.3 million shares distributed to directors, and 28.2 million shares contingent on the failure of the FAIR Act. The total number of outstanding shares is then 131.4 million, assuming the FAIR Act does not get passed. In the 10-Q, OC management wrote that they believe the likelihood of passing the FAIR Act is fairly slim. I imagine this to be the case too with the new mostly Democrat Congress.

The free cash flow of the company for 2005 was $463 million. Since this free cash flow number occurred during potentially one of the best years for building material suppliers, I don't see this as sustainable. The growth rate over the last five years appeared to be around 15% and projecting that into 2006 gives an estimated best-fit free cash flow of $287 million. Using this value, a 12% discount rate, and assumed 10%/5%/3% staged growth, I get an instrinsic value of $35 for the shares. At current prices around $29, there is a margin of safety of 17%.

At this point, I have made too many questionable assumptions for me to reliably use my IV estimate. I would like to wait for a cheaper price and more information before I re-evaluate whether or not to buy these shares.