October 12, 2014 Comments

On Friday, Stocks also got cheaper. The S&P 500 was down 1.2% and Toronto was down 1.6%.

For the year to date Toronto remains up 4.4% and the S&P remains up 3.1% while the DOW is down 0.2%.

Our two Strong Buys from January 1, 2014 remain up 12% (wells Fargo) and 13% (Melcor). Our 15 stocks that were rated Buy or higher are up an average of 5.0% each. My own portfolio with a heavy weighting in Melcor, Wells Fargo and a few others remains up 7.3%.

Markets and the gains on this site are down from what they were earlier this year. But it is never realistic to expect to invest in stocks without periodic declines. The recent declines are relatively modest. I don’t think it is possible to predict the direction of markets in the short term. Owning shares in profitable and growing companies has always worked out well in the longer term. Shorter term volatility is basically the price we pay to enjoy the longer term gains.

An order I had in to add modestly to my large Melcor position if it hit $23.10 was filled as Melcor closed at $22.71. Melcor is now trading at 95% of its book value. It’s assets are strong. 47% of its assets are investment buildings that are rented out. These are marked to market which means they are fully valued in the book value. 39% of its assets consist of its land inventory. This is reflected at cost (including costs to develop the land and capitalized interest) and is almost certainly worth more than book value. The remaining assets are mostly receivables and cash and would be worth book value. Melcor is also trading at 10.5 times trailing earnings (with the earnings adjusted down to remove gains related to marking buildings to market). But its earnings are cyclic.

In this case the chance to buy assets and this business below book value seems quite attractive. If you were to start your own such business today, you would have to pay market value for the assets which would be somewhat more than Melcor’s book value. And it seems unlikely that you could be as profitable as Melcor given their years of experience and their scale.

The main risk with Melcor is that due to lower oil prices or for other reasons sales of new building lots in Alberta could slow substantially and/or the prices could drop. I don’t have access to market data but I am not aware of any such slowdown. The company will no-doubt provide an update int his regard when it releases its Q3 earnings in about one month from now. Melcor has weathered such slowdowns int eh past but they do tend to send the share price down when they occur.

There are always risks, but I view the chance to buy this business at slightly below book value to be quite attractive.

The stock is thinly traded which makes it more volatile and which also can allow the share price to deviate further from its intrinsic value than is the case for most companies.

On Friday I also bought a small amount more of Canadian Western Bank and Toll Brothers to take advantage of the lower prices.

By my calculations, Toll Brothers trailing adjusted P/E ratio is 20.3. Still not cheap but much lower than it has been in some years. I expect it to report increased earnings int he next two quarters based on houses it has already sold and is int eh process of building. Warren Buffett said last week that the housing market recovery has not been as fast as he expected. He expected to to continue to recover. He stated that that with Americans able to lock in 30 year mortgages at very low rates (and to refinance if rates get lower) it was a no brainer for people to buy houses. (I believe he is taking into account that houses in the U.S. are reasonably priced and he referred to new families starting out). His comments add to my comfort in holding and buying Toll Brothers.

Canadian Western Bank is not cheap but tends to grow earnings fairly steadily over the years and the recent price drop provides an opportunity to accumulate some shares for those interested.

For fixed income, I like Boston Pizza. It would decline if long-term interest rates rise substantially but at the moment that does not appear to be imminent.

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