Distressed credit buyers opportunity?

They say it's an ill wind that blows nobody good - meaning that even in times of turmoil, there's often someone who's situation is improving.

With that thought in mind, I recalled the recent turmoil in the credit markets, and wondered what companies might benefit from this situation. Leafing through my investment scrapbook, I came across an entry I made some two years ago, suggesting that if the US debt situation imploded, that a beneficiary might be those whose business profile sound like this ...

... provides outsourced receivables management and related services in the United States. It engages in the purchase, collection, and management of portfolios of defaulted consumer receivables. The defaulted consumer receivables are the unpaid obligations of individuals to credit originators, including banks, credit unions, consumer and auto finance companies, and retail merchants. It also provides collateral-location services for credit originators, collections and revenue administration, and audit and debt discovery/recovery services for government entities.

... in other words, those who benefit from a higher default level on any type of consumer debt, since a higher level of delinquency is inevitable, given the negative savings rate of the average American family. Given that, opportunities to load up the balance sheet for these companies with cheaper than ever defaulted debt, at favourable prices, appears better than in recent memory. This could fund very profitable growth for these companies for some years to come.

Some names in this space include:

Portfolio Recovery Associates - PRAA
Encore Capital Group - ECPG
Asta Funding - ASFI
Asset Acceptance Capital - AACC
First City Financial - FCFC

This is an idea worth exploring more for your own portfolio, if you think, as I do, that the ill wind is blowing towards these companies right now.

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JW

The Confused Capitalist

Informants in the investment process - rating and ranking

Separating good leads from bad is crucial in assessing investing leads. Avner Mandelman of Giraffe Capital has a method to do so.

Essentially, it's from a page stolen from spy agencies. In order to be able reliably assess information coming from a variety of informants, some sort of ranking system had to be devised.

These agencies rate their information from informants in two ways:

1. Based on the past track record of the informant, and,
2. Based on the informant's confidence in this particular piece of information.

Similarly, in assessing investing leads, whether they come from brokers, analysts, industry sources, customers, etc. we can assign a letter grade rank to each of the above. For instance, an industry source who has proved highly reliable in the past might be assigned a letter grade of "A", under point 1 above. Secondarily, they provide you with a particular piece of information that they claim they are highly certain is accurate (another "A", but under point 2, above).

This can provide you with a certain level of confidence in using this information as part of your investment process. For instance, an "A" ranked informant with an "A" piece of information would play higher in your investment process than a "B" informant, with "C" level information.

Mr. Mandelman even suggests that those so poor at any type of accuracy, can eventually become "A" level informants, by being contra-indicators. In other words, you studiously avoid their recommendations.

Of course, all of the above pre-supposes that you start tracking and rating your own informants, and keep those in your investment scrapbook. A worthwhile idea, in my view. By the way, I rate Mr. Mandelman as an "A" source.



JW

The Confused Capitalist

Ignoring the rear view mirror when investing

Just like you shouldn't invest in home-builders shares right now, I'd also suggest that you stay away from anything which depends mostly on new home construction for a bulk of its' revenues. Such is the life of an OSB maker right now. Two Canadian forest products companies holding two of the top five spots, globally, for return on capital in the industry, Ainsworth and Norbord, have seen their share prices continue to slide in the face of weakening US home sales.

However, just like the home-builders, you shouldn't invest in them when their PE ratios are absurdly low (like the 2.2 and 5.1 they are currently). Better to invest in them after several years of poor home sales, when the likelihood of an upswing in home construction would boost earnings significantly. Buying today, at today's prices (even though they've fallen significantly), is like driving using only a rear-view mirror.

Something to think about, and perhaps even put in your investment scrapbook to pull out in a few years from now.


JW

The Confused Capitalist

Proxy Investing

Great post over at Abnormal Returns relating to what he (she?) calls proxy investing. Essentially, it's finding a favorable trend, then figuring out what companies will benefit from that trend. Essentially, that company you invest in, is a "proxy" way to invest indirectly in the trend itself.

A checklist is provided so that you can analyze your chances of using this profitably.

I highly recommend you take a visit over there, and perhaps add this bit of wisdom to your investing scrapbook.


JW

The Confused Capitalist

Staying the Course

Having some faith in your positions is crucial to long-term portfolio outperformance.

This implies that you have enough confidence and knowledge of why your investment choices are sound, to stick with your strategy during the softer markets. Much potential portfolio outperformance has been undone due to a lack of knowledge and faith in choices, by selling out during a weak patch.

That's one reason I favor an investment diary - writing down what I picked and why, and then reviewing those writings before I buy or sell. Although I've been practicing this for less than a year, I find it's already helping me reduce my portfolio turnover, increase the clarity in my investments, and provide me with better confidence to continue to "stay the course" over the past while. I think that this has been at least partially responsible for helping me to produce a return rate in my own portfolio over the past year in excess of 30%.

I highly suggest that you start an investment diary, together with an investment scrapbook. Both are "capital ideas" likely to improve your investment performance.



JW

The Confused Capitalist

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Scrapbook Your Investment Ideas

One thing that I've done in the past as an investor that's lowered my returns has been to flit around from stock to stock whenever I come across a "good idea". This has dampened my returns, since I haven't had the full patience to wait for my other good ideas to come to proper fruition (ie waited for the market to properly value them) and I haven't considered those ideas within the context of other investment ideas that seemed profitable.

I've now worked out something that works much better for me, and it just might for you too.

And that's to toss all these ideas into the equivalent of a scrapbook, with a couple of notes about where you came across the idea, what seems so good about it, and anything else you happen to have on had about it. Now, unless it offers an absolutely stunning value opportunity to be exploited immediately - then you can just sit on it for a bit, and wait.

Then, every couple of months, you can go through your accumulated ideas, perhaps examine some basic valuation metrics on it, and see how it might blend into your investment portfolio to date. Make sure you ask yourself a few questions about it - but you also get the opportunity to compare it to your other "bright ideas" and at least consider the risk/value issue in a broader context - ie other opportunities you're actively considering.

I almost guarantee that this sort of activity will lower your trading profile and increase your returns, unless your portfolio suffers from comatose activity, in which case I believe it will then both increase your trading and your returns.

A beneficial activity in either case: scrapbooking - it's NOT just for the bored housewife anymore!


JW

The Confused Capitalist

Lift Your Investment Returns

In addition to the planning items I've recently discussed in the last two postings, there's also another way to raise your investment returns.

And that is done by analyzing what you have done with your portfolio over the past while, perhaps a year or so. Because if you stop to look and think about your various trades, you'll probably be able to glean some insights into your own investment personality.

For instance, you might find that you are drawn to the latest and greatest growth story, something that was discussed in the fascinating research paper, The Seven Sins of Fund Management as Sin Number Six, or you might be more subject to Sin Number Five. Whatever; the point is that if this particular investing flaw is causing you to have a lower than potentially possible return, then you need to do something about it. And that can only be possible by realizing you are doing it, looking at it, seeing it, and hopefully choosing a strategy in the future that allows you to minimize its effects.

On the other side of the coin, analyzing your pattern of trading and investing also allows you the opportunity to exploit your strengths to even greater advantage. You might find that you are doing one thing particularly well, that is adding some dollars to your investing each year. If you realize it, you might be able to figure out a way to take even greater advantage of it.

In an analysis of my own investing over the past year or so - done by looking at all my trades - I came to certain conclusions, some of which are as follows:

Right things:

• I accurately over-weighted my portfolio when I found a cheaply-priced (ie low pe) fast-earnings growing stock (but I could have done this even more, I see in hindsight);
• I accurately purchased additional position, when I saw a stock
  suffering from a temporary weaknesses.
  

On the other side of the field, some of my bad habits were:

• Bought too many micro-cap "story's", that lacked adequate net earnings and these returns impaired my overall return (and also increased my propensity to trade often);
• Bought some expensive (ie high pe) fast-earnings growing stocks, and that also impaired my returns.

The point here is that I've looked at both things I done right, and mistakes I've made in a considered way. In the future this should allow me to do, respectively, more of the first, and less of the second. Thus improving my overall investment returns. If you do the same, you'll see certain things you have done, or habits you have, that become more obvious to you. This allows you insight into your investing style and worries - thus providing you with the opportunity to raise your future investment returns by modifying your behavior.

A little more on this topic later ...

JW

The Confused Capitalist