Blessed by the Potato

Well, time to fess up to another investing mistake: I’m not Ben Graham. The story behind the mistake is that I invested in a small biotech company shortly after it’s IPO (this is not the part where I thought I might be Ben Graham). As a scientist I thought that I understood their tech and that it looked good and that they could make it big, and essentially gambled a small amount of money on the stock.

Things went poorly, as they so often do, and the share price tanked. It tanked so far in fact that the company was trading at about one-tenth its remaining cash on hand. Since it was still fresh from the IPO it still had cash on hand and wasn’t neck-deep in debt or anything, so I figured that rather than bail on my initial position (which at that point was worth less than the commission it would have taken to sell out), I bought some more. This is where I did mistake myself for Ben Graham. I figured that since it was at such a discount to the cash it just made sense to buy it up while it was still in distress from the poor results. It was a one-trick pony, and that pony had just been brutally killed, so I saw no way that they could continue as a going concern. I figured that they were either going to raise more cash and take another go of it (which was contra-indicated by the wording of the announcement of the failed clinical trial), or close up shop and distribute the remaining cash back to the investors, with the second option being far more likely.

They just recently announced that they managed to sell their patents, for an amount that alone would have made the company worth five times what it was trading for at the bottom, but in the deal they were only going to distribute a tiny, tiny fraction of that as cash to the investors. The rest of the cash would sit in the company to “pursue other opportunities”. There’s been no prospectus or guidance yet as to what form those opportunities would take, but with no patents and a small (but not insignificant) mountain of cash I don’t see how a biotech company can really pursue any opportunities. I was just not seeing how this deal would return value to me, so I bailed today when the stock went up a bit. I ended up doubling the small amount I bought after the bad announcement, but it was a ~60% loss over all because of that larger first bet, and still only about 25% of the book value. I might have sold too early, and when the details of the arrangement come out along with the proxy forms then maybe I would have seen the light, but I was also eager to just get out and not see this 60% loss in my portfolio every day.

I was quite able to look at the (very simple) balance sheet and do the math as to how undervalued the shares were, but what I failed to realize is that I don’t have the power to actually get the value out of the corporate shell — I couldn’t buy up a majority of the shares and bring about a liquidation, or charm the board of directors. Even if I could have identified another 50 such companies to hope value returned in enough of them for it to be positive overall, I don’t have the resources to take a position in all of them…

As a small-time investor I’m just along for the ride.

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First off, a series of disclaimers.

1. I’m sick at the moment with a nasty hacking chest cold and I just chipped another tooth, so I’ll be looking at another stupid thousand-dollar crown in the near future. I didn’t even bite down on a tic-tac or anything like that: it was just that an old filling was starting to come apart, and I lost part of the tooth as the decay got in and there was only a small bit of natural, healthy enamel left holding the back quarter on. So it would be fair to say that I’m a little grouchy at the moment, so take anything you find offensive in the rant with that in mind.

2. Wayfare has accused me of wanting a housing crash and moreover of wanting reasons to delay buying a home for a few more years and having a case of confirmation bias where I seek out evidence and articles that support a crash coming to Canada. Likewise, I accuse her of the same thing, of wanting to fulfil the dream of homeownership right now so badly that she ignores the doom-and-gloomers and focuses on anything that indicates that now is the best time to buy (or better yet, that January 2010 will be). I hope that the downturn will be quick, like ripping off a bandaid, and that we’ll be back to decent values by then, but I fear it’ll take a few years, like it has in the States. Of course, our respective confirmation biases don’t really help the discussion one way or the other, but it’s important to acknowledge that I do look at the data with an eye to how that housing downturn is coming along.

3. I’ve ranted a few times before about the real estate market, so some of this may seem like a repeat. Hey, what can I say, I just don’t have that much new material, and it’s not that fast-moving a market.

On to the rant, which is really a series of interconnected mini-rants.

Rant #1: the Rent vs Buy rant. I talked a bit about the rent vs. buy calculations before, and discussed the merits of the two ways of finding shelter. In a comment at Bad Money Advice this was put even more plainly: you can rent your dwelling from your landlord, or rent the money for your dwelling from the bank. Anyhow, after talking with a few people (homeowners or hopeful homeowners) about how renting is not blindly throwing your money away some of them came back somewhat vehemently with two points: that you need to own so you can have control over the property, and the forced savings. For the latter a real-world example was used of several people (no one I know closely) who are unable to save unless forced to by a mortgage. Even though they knew owning would cost more than renting (thus depriving them of money they so love to spend) they would rather own because then they build equity. Now this is unfortunately the fault of the CMHC and zero-down mortgages, but someone who can’t save doesn’t need a house, they need help. Whether it’s a shrink or an inappropriately starchy friend with a calculator and some graphing paper, a mortgage is not the answer. For the near term, for the good times they will build equity by having to pay down that mortgage, but that isn’t enough. And, it puts them at risk: if they lose their job and can’t pay the mortgage and have no other savings they could get foreclosed on, lose their house, and their life savings along with it! Whereas someone with actual savings would just dip into that to pay the rent…

The other reason for needing to buy, to personalize your space, is way overstated. People don’t seem to appreciate both how much freedom you do have as a tenant and how little most people actually renovate. Heck, for the first three years after I moved out I had white, barren walls because I didn’t dare paint or put any holes in them. But you can paint however you want, the only stipulation in your lease agreement is usually that you have to paint back to white (or whatever it was) when you leave. Hell, look at my bedroom: the last tenant painted bugs on the walls for her daughter! (they were awesome, so we chose to keep them, which also let us take over the place a week earlier since they didn’t need to repaint, which made moving much easier) Likewise, you can put holes in the walls to hang pictures or install shelves, but you can’t get too ridiculous (I don’t have a legal definition on “ridiculous” though). Moreover, nearly anything is negotiable with your landlord: want a new fridge or stove? Heck, want a natural gas fireplace in the living room? If you’re going to stay there a while and were willing to pay for it anyway, why not discuss it with the landlord? Now of course it’s harder to bring yourself to spring for a full kitchen remodel, or to convince the landlord to bang out a wall to open things up, but those sorts of renovations are much rarer than people seem to feel they might be when they need to have that control — and vice-versa, people looking at condos will find they have much less control over radical renovations than they might think. Sure, at some point in your life you’ll probably want your dream home kitted out just the way you want, but you don’t necessarily need to get into that with the first place you move into after your parents’ basement.

Rant #2: the Silly Real Estate Agents rant. It should be said that there are a number of real estate agents that just need to be taken out behind the shed and put down. It’s a field with very little repeat business, low barriers to entry, oh, and it’s commission-based. So there’s a lot of incentive for agents to be greasy sharks, and to be constitutionally unable to see past their own efforts to rationalize that now is always the best time to buy. They pass off their failures to properly price the market as victories, but the thing that really cheeses my nachos is that they charge tens of thousands of dollars for their services, the most important of which is access to their exclusive listing system, and they can’t even take a minute to proof-read, or spend the $5 to have a high-school student do it for them. That’s leaving alone the issue of not taking advantage of the ability to post pictures to MLS.

Of course, not all agents are all bad, but they can have a silly side. One has a blog that I just found and read a few posts on. He’s a decent writer, and for the most part has his head on his shoulders, but still says a few silly things about property values. In one post he talks about the difficulties of assuming a tenant can pose to selling a property. The points he makes are valid, but he ignores the elephant in the room: that the condo in question is flaberghastingly over-valued (and what rosy realtor(TM) glasses he must be wearing to call it “a very attractive price”). While it can be a pain to deal with a tenant if you just want to just live somewhere, having one who wants to stay can make the life of someone looking for an investment property much easier. In this case a potential investor can’t fool themselves about what market rent might be, it’s right there in the listing that this unit screams overpriced. The asking price of $575k is 230X the monthly rent of $2.5k. At a generous 5% interest rate/opportunity cost on the purchase, the cash flow is already down to about $100/mo, easily coming to a loss with just the condo fee, let alone maintenance or vacancy allowances. Yet just two weeks later this guy talks about a four-plex being overvalued and having poor cap-rates, and at the current rents it is rough, at 270 times rent — but if he’s right and the rent could be $1600/mo for each of the four units, then it’s just 203X, a better buy than the very attractively priced condo he talked about two weeks previously! (and it could be better yet since they added a 5th unit to the basement!) One more example with a price-to-rent of 260X, yet the conclusion is “I’m shocked that this house is available at a ‘paltry’ $1,299,000. But I’m not so shocked that nobody is banging down the door to rent it for $5,000 a month…” Yet again he doesn’t see the buy vs rent logic: if the interest cost alone is closing in on $5000 per month, why wouldn’t someone who wants to live there consider renting it at that price? The only reason I can think of is conspicuous consumption/pride — people don’t rent million-dollar mansions.

There are other factors to consider, of course, not the least of which being the cracked foundation mentioned. But one distinction is that one was a luxury condo, and the other was just a regular brick four-plex. For some reason condos make people in this city stupid. You’d be hardpressed to convince a group of homeowners to band together to pay monthly for services they didn’t really need, like having a surly security guard patrol the neighbourhood at night. But, call him a concierge and have him nap behind a desk and you’ll get condo owners springing for it in their monthly condo fees every time.

To give credit where credit is due, I think anyone thinking of buying a pre-construction condo (if any still exist, as many pre-construction projects have been cancelled) should read his post on why that ship has sailed.

Rant #3: A Conversation With My Dad: In the mid-80’s, my dad left a small job at a major accounting firm to start his own company. His financial consulting business covered a lot of bases, but developed a focus on assisting clients through bankruptcy (or skating around it). In the late 80’s and early 90’s this part of his business took off, and one thing he had to do a lot of was evaluate and dispose of properties. I knew he had been all over Ontario and parts of Alberta looking at houses and to a lesser extent, office buildings, helping to arrange for hundreds to be sold, but I was just a kid at the time and there wasn’t really much call to talk about it since. With the downturn in real estate coming though, it’s looking like old times to him, with the first sign being the freeze in sales, especially at the higher end (and around their house there are dozens of listings that are now closing in on over a year for sale; others that spent months on the markets and were delisted, but still don’t have drapes in the windows).

We took a walk around the neighbourhood one day with the dog pointing out houses for sale, and ones that obviously weren’t lived in. The beginnings of the end could be seen in some, for example one house a builder obviously ran out of money and has been sitting with the inside unfinished. For sale, as-is 1.2M, or 1.46M if finished, and over a year on the market (in another realtor blooper, the picture with the for-sale sign and snow on the ground has a date of February 2008).

Oh, that listing I linked to above with the spelling errors? It’s actually been relisted with a new price and a new host of spelling mistakes (and oops, he also forgot to take the old listing down). $600k to $520k, a 13% decrease. Still more than I’d pay for that house, but getting there. An improvement over the 2% drop for the other pair of houses that have have been sitting for over a year just down the street from that one, and it might actually move.

Back in the very beginning of the 90’s he was faced with a client’s home to dispose of. It was in a small town north of Toronto, and there were a dozen nearly-identical houses all sitting for about the same price — their 1988 price. And some of them had been on the market for over two years without entertaining an offer. But since the last completed sale in that small, illiquid market might have been in 1988, that was the only set of comparables the agents had to work from. It was clear at that point that the only way to get things to move was to “lead the market lower”. So they put the house up at 15% less than all the other homes were at, and they got a buyer. That got the whole market for that town moving again — generally lower and lower each sale until it bottomed out, but at least people who needed to sell could.

This time around it is a bit different. Things are still fairly seized up, and sellers are hoping that the nice weather of spring will make it all better and they can get what their house is “worth”, but the buyers aren’t buying. Someone will probably start leading the market lower before the volume picks up again, but the low interest rates are confounding that, making things appear affordable because the monthly payments are lower.*

We also had a long, painful discussion about what to do about the family cottage in northern Ontario. Last October the stock market was crashing, and it was looking like we would have to sell the cottage; Wayfare and I were up there on our honeymoon, and we very nearly had to hang the for sale shingle on our way out. When things stabilized (however temporarily) and my dad’s heart stopped racing, we were thrilled that, while things were not as good as they were last year, they were not so dire that we would be forced to give up things like the cottage just to keep my parents in retirement. However, over the winter we had some really nasty weather, with snow squalls pretty much every week. My parents didn’t make it up there even once a month, and with my dad’s poor health it’s not like they snowmobile or go boating anymore anyway.

So the issue went from having to sell the cottage to one of maybe we should. On the one hand the cottage costs a fair bit every month to keep up, money that’s just wasted if my parents are only going up once or twice a month now (they used to spend more time at the cottage than in the city, when they did snowmobile and swim and paint the deck or cut down a tree just for the sheer hell of it). They could spend a few months in South Carolina every winter just on the money saved in property tax and energy, let alone the opportunity cost of the equity in it. While they used to sometimes go up just for a few hours and drive back the same night, the cost of gas is not negligible anymore, and not getting cheaper. Plus as painful as it would be to sell now, as frozen as the market is, it’s not likely going to get better in my estimation. We could be the ones to lead the market in that area down, since it’s still frozen for now, and get a decent price (even if it is ~20% less than what we could have got last year). I figure if they’re not enjoying it like they used to, my parents might as well sell it. Being down in London I only make it up there once a year, and my brother only goes a few times a year himself, despite still living in Toronto. However, the other issue is the long-term destiny of the cottage. Despite the expenses, might it be worthwhile to hold onto through the next few years of limited use so it’s still in the family when us kids have the opportunity to go more, when my sister and I finish school and move back to the city?

* – I drafted this in London before leaving for my dentist appointment, but after arriving in Toronto I see that the market, bewilderingly, isn’t completely frozen. There are a half dozen “sold” signs up, and the place across the street from Wayfare’s parents, that had been up for so long the paint on the for sale sign was fading also finally sold (though we have no idea how much any of the properties sold for). Of course, in some cases I have to wonder if the agents weren’t just putting sold stickers up on houses that were merely delisted: one had Re/Max (I think) sign up for 6 months that now has “sold” plastered on it, and right beside it a new for sale sign from another brokerage has cropped up. Either someone is taking this house-flipping thing a little too seriously, or the representation changed after no action was had and a misleading sold sticker was put up (I kind of doubt CREA regulates the use of sold stickers). While I’m a big believer in the rent-vs-buy calculation and price-to-rent ratios for determining when things are overheated, which to me points to at least a 25% downturn needed in Toronto, perhaps 10-15% is all we’re going to get if that’s all the price reduction it took to get these properties moving again… I still feel it’s probably a “bear market rally” driven by low interest rates, nearly meaningless tax credits, and buyers that couldn’t out-wait the sellers… but I’m not as sure of it any more.

I was playing around with some data analysis here at work, and decided that I’d try to do a little log transform on some stock market data. Generally, you expect the market to increase exponentially over the long term. This leads to some pretty big numbers after some time, so a chart looks something* like this:

It’s an impressive chart, however the thing about exponential growth is that after a century we’re dealing with some very large numbers. In fact, the last few decades seem to dominate the chart: the recent market crash and the tech issues in the 2000’s appear, on that chart, to be way worse than the great depression, which looks like a small blip in the 30’s down in the bottom of the range. We could of course zoom in on that region:

Showing that there was a big nasty swing in there.

So one way to better look at data over the real long term like this is to do a log transform (in this case, I chose base 10). That takes an exponential growth curve and makes it linear. Now instead of being dollar value up the y-axis, we now have powers of 10.

This is a different way to view the data. To my eye, the long-term trends seem to stick out more, and the current crisis can be put into perspective with past issues. The stock market crash of the 30’s, from about 380 to 41 was a fall of almost 90%, or about a drop of one power of ten, which would be 1 unit on the logarithmic scale. Right now we’re down about 50%, or 0.3 on the log scale.

I like looking at the log plot, because it shows that over the span of multiple decades that there is some consistency to the stock market going up, and that while this recent disappointment is crushing (down another 3+% today!) it’s not totally unprecedented. It also helps restore my sanity after reading some extreme bears who point to that 100-year chart and say that the world went crazy in 1985 and everything that happened after that was crazy and volatile and that if we fit a line to the rest we’d be back down to 2000-4000 and that’s where the Dow is heading! Of course that’s really just an artifact of the magnification of exponential growth — you can’t fit a linear trend to an exponential curve (ok, for small values you can, which is exactly the error they’re making!). If you want to draw a straight line, then you should work from the log plot. While I don’t put too much faith in chart divination, I think I might have this one printed off:

The market can underperform for a long time (the market can stay irrational longer than you can stay solvent, as the saying goes), but with a timespan of 20-30 years (when I’ll be 50-60) it should come back to that long-term trend. It doesn’t help me figure out when we’ll bottom, or when we’ll get back up, or even for sure if that’s an accurate projection of what will happen in the future, but it will help me sleep better knowing that essentially all of my net worth is subject to the whims of the market. For the curious, here’s what that same trendline looks like on the untransformed data:

Exponential growth is everywhere in nature, but I bet at least half of you are shaking your heads at that 25,000 by 2020 extrapolation! It’s just so hard to wrap your head around numbers that large, though that would only be a ~6% return per year from the peak (about 11% per year from where we are now).

* – Note, I was getting some Y2K errors with the data I have (starting from 1900 — I just did a Google search for DJIA historical data and took the first one), I think I fixed it up, but might have made some mistakes. Feel free to fix if you like. To improve on this analysis you can include dividends, inflation, and compare multiple countries (I doubt things would look as good in Japan, for example) or run a monte carlo with sample portfolios to get some confidence intervals. These are left as exercises for the reader.

Also, for those on the RSS feed, the images may not come through. Try viewing in your web browser.

Well, right on schedule, Rogers is forcing through another egregious price hike, in the face of a recession to boot. They’re increasing the price of most services, including bizarrely enough the price of basic cable, by 5%, much higher than the rate of inflation. Basic, analog cable that they are actively trying to phase out. Yes, I suppose increasing the price might get some people off of it (which is their goal, since digital is a cash cow for them), but it makes these price hikes seem like even more of a kick in the pants, since they haven’t put any work into basic cable for years now (at least with the internet they can claim to “add value” every time they hike the price and cut the cap).

I’m getting really sick of it, especially since I hardly ever watch TV anymore. Unfortunately it looks like we’re stuck with Rogers. I figured I’d be fine cutting the cable and going back to over-the-air TV as long as we got a half dozen stations (CBC, City, CTV, Global, maybe a few american stations if we’re lucky)… but we just borrowed a UHF antenna and only one channel came in — and it was A-channel. Ugh. I found that surprising. Maybe it’s something to do with London (I know in Toronto we can pull in most of those stations without an antenna, the signal is so strong), or maybe it has to do with the fact that we’re in a little bungalow with a series of giant apartment towers blocking any signal to our south side. It feels like we’re completely at Rogers’ mercy here.

That’s made even worse this year by the fact that I’ve just gone over a day without cable service — a whole day without internet! Right there that takes Rogers down to “zero” nines for reliability: 99.7% uptime and getting worse the longer I’m sitting here…

Well, these are interesting times.

On the work/school front I got a bunch of MRI time for the hospital for my project on the weekends, so I’ve been scanning like crazy. Assuming that I don’t have to go back and increase my sample size for statistical purposes and that not too many people stand me up, I should be finished the scanning part next week for this phase of the study. That’ll give me a month and a half or so of data analysis to do; hopefully I’ll be ready to start the next phase within a month or so so that there will be a bit of overlap and we’ll get things done a bit sooner.

Unfortunately, I’ve also been hit with a bunch of other work (abstracts, papers, committee meetings, phase 3 prep, etc) that all sort of came together this month in the perfect storm. The last day off I had was January 24th, and I was hoping to take this Tuesday off to give my brain a break, but I just found out I’m going to have some MRI training all week (I was told only “it starts monday at 9am” and assumed it would be one day, until I got the schedule on friday), and then more scans for my project on the weekend… so by the time I do get a break I’ll have gone 27 consecutive days. I’m pretty sure that’s against the labour code (actually, I looked it up, it is… but grad students don’t count). Ah well, science does always seem to go in fits and bursts… hopefully this craziness will clear my plate enough that I can have a few extra relaxing days on the patio when the weather turns nice.

Plus they’re not necessarily short days. Yesterday I was here in the MRI for 15 hours… and I couldn’t even leave; I had so much food in my bag I swore I was going to rip it open, and even then I ran out by 5 pm and my stomach was just growling by 2am when I finally got to leave. Speaking of yesterday, it was not a good day. Ok, good in the fact that hey, I scanned 5 people (almost 6!) in one go, which is a decent dent to my project (and another 5 today in just 13 hours). However, it started off with me waking up to the sound of water dripping into the back room. The weird thing is that the water was coming in through the frame of the window, and it’s not exactly like the snow was pressed up against it on the other side, so it’s leaking through the walls somewhere and then coming out the window. With the scans I just didn’t have the time to deal with it so I just threw some towels down and hoped for the best. I was having visions of the whole back wall of the house melting away while I was at work, but not much more water came in through the day than was there when I woke up. The glacier on top of the house also seems to have cleared up. As much of a pain as that was, I’m really glad we finally had a bit of a spring thaw: that snow has been building up since before xmas, refreezing harder and harder each night after we had a sunny day.

I had one subject just not show up for her MRI. No email or call to let me know, just stood me up. And the sad thing is that that’s not uncommon. WTF? Have some common courtesy. Other than that the day went fairly well up until my last subject at midnight. Just as we were getting set up the power went out and the scanner put up all kinds of error codes (ok, just the one, but it was bad), so I sent him home to be on the safe side, but still ended up staying until 2am just trying to reset the system and make sure everything was still working. As far as I can tell I haven’t been making any mistakes (aside from grammatical) with the sleep deprivation and the “always-on-ness”, but I’m definitely starting to feel my age. I’m also really glad I’m essentially just running a computer (3 actually, but same difference) and not performing surgery on somebody.

In the world at large the economic news has not been good. So far through all of this mess I’ve been stupidly optimistic: I figured it was a crisis of confidence, a liquidity problem, an issue of essentially worthless mortgages and commercial paper that would lead to some losses around the board, but that the economy as a whole would survive, and that there would be bargains to be found in the stock market to throw money at… and that the housing market would turn around at its own glacial pace and come back to earth. As time has wore on I became convinced that we were going into a recession (and are now in one), but again, that things would come around.

Then the unemployment numbers for January came out and I nearly shit my pants. Check out the picture at the Big Picture. That’s for the US, which lost ~600k jobs in January; Canada lost ~100k, more proportionately than we should have by population alone. The recession is catching up to us, big time.

Look above: I’m getting some crazy MRIs in; my project is actually making progress, which means at some point (probably early 2010 if all continues to go according to plan) I’m going to leave grad school and need a real job. This is scary stuff, and isn’t likely to be over in 6 months to a year.

At least it’s finally warm out.