Fathom the outcomes

My editorial on You Tube

Here comes the next update in my process of self-learning about investment in financial markets. In the last update ( Back in the game ), I briefly sketched my starting point, i.e. my first handful of financial positions, and my long-term goals. According to a pace I set for myself, once a month I make investment decisions. Why once a month? Because once a month I collect the rent from an apartment I have in town. My basic concept is to invest the rent I collect on one form of capital – real estate – into another form of capital.

What should be my next steps in investment? What should be my strategy? I start by studying my expectations. What do I expect? Shortly and honestly: I expect to beat the index. In the jargon of investment, it means that I expect to achieve abnormally high returns on investment, higher than the returns offered by composite indexes for the stock markets where I invest. Lots of people expect to beat the index, most of them fail, so what makes me expect that I can do it? Well, I can quite clearly pin down situations, in my own past experience as investor, when I managed to beat the index by many lengths, and other situations when I failed lamentably.

I had one success, which gives me some confidence. My success name was Bioton, a Polish biotech company.  I had an eye on them for many years, I worked on their case with my students, and I knew they have good foundations. Innovative enough to launch an original substance of their own – synthetic insulin – and conservative enough to diversify their business into good old generics like basic vitamins, antibiotics or basic vaccines. My investment story with them began in January 2014. At the time, the founder of the company, Mr Krauze, suddenly sold out all of his participations and essentially disappeared from the business landscape of Poland in quite mysterious circumstances. There was a healthy business in a reputationally shitty spot. Their stock price hit an all-time low: 0,03 PLN (less than $0,01) per share. WTH, I thought. At this price, there is not even much to lose. I bought. Two and a half years later, by the end of September 2016, I sold those shares at 10,04 PLN (something like 3 dollars). Yes, I made 33367% of profit on that one. Had I been less timid in opening my initial investment position, I could have bought some real estate with the proceeds. By the way, as I have a fresh look at Bioton, they seem to be back almost to the point where I invested in them. Ever since Autumn 2016, their stock price has been falling. Now, it is at 3,5 PLN per share, which is pretty low, and as I study the graph of their price, they are likely to hit, quite soon, that bottom plateau between the horns of the bull. I need to study their fundamentals, but it looks like the next good opportunity to open an interesting position. I check, and it looks tricky.

I mean, it usually looks tricky. At Bioton, they are losing money: at the end of the 3rd quarter of 2019 they had an operational loss of more than $30 mln. Those fundamentals look bad in the context of their business history. Their stock price tends to nosedive, and there are fundamental reasons to that. Still, they remain undervalued as regards the ‘market to book’ ratio. Calculated as ‘market capitalization divided by equity’, it makes PLN 300,52 mln / PLN 621 mln = 0,483851232. In other words: there is room for making money on this position, at least to a ‘market to book’ coefficient of 1,00, i.e. up to a stock price of about PLN 7,2 ÷ 7,3, which would give a gain of more than 200%. 

Miracles happen quite unfrequently, whence their reputation. Still, I can say ‘Gotcha’!’. That’s the strategy for my investment, which I have been turning and sniffing around for during the last 2 weeks. I had to recapitulate those past events in order to bring those thoughts into daylight. What I am looking for are companies with healthy fundamentals, i.e. with reasonably good financial results and prospects for just good a near future, which, for some reason, are deeply undervalued.

The next step is to run all my present investment positions with the same test. One, check their fundamentals.  Two, check their relative market valuation, denominated over their equity. Three, check the price curve and try to locate the present price of my investment position, so as to check opportunities for growth. I start with OAT – OncoArendi Therapeutics. I am having a look at their quarterly financials for Q3 2019. They lose money, as typical R&D-focused biotechs frequently do. They have very little revenue and much bigger operational costs. They lose cash, too, which is more worrying. When I sum up their operational cash-flow (-2,04 PLN mln) with the investment-related one (-7,3 PLN mln), and with the financial one (6,69 PLN mln), the bottom line is negative, by almost 3 millions of Polish zlotys. I have a look at OAT’s stock price, and I see that I behaved dumbly: I bought their stock right before a local peak, which is now being followed by a descent. I bought on the back of the bear, in the stock-market jargon. Their ‘Market to Book’ coefficient is 164,04/80,08 = 2,05. I see I really need that slow, grinding learning investment by writing about my own investment. That’s what I can call a perfect mistake: bad financials, supposedly overappreciated stock.

I move forward with APREA THERAPEUTICS. The fundamentals are weak and look a bit foggy. They certainly lose money, with a net loss of $6,25 mln in Q3 2019, twice the net loss one year earlier. Technically, the company has no equity in the strict sense of the term. What I bought are some convertible securities. Still, those convertibles, apparently not burdened with any liability, amount to $47 393 333,00. The market capitalization, according to Yahoo Finance, is $664,35 mln, which gives one of those crazy ‘Market to book’ ratios: 14,02. Well, if I was looking for an undervalued biotech company, this is quite the opposite of what I should have bought. Next, FREQUENCY THERAPEUTICS INC.  An interesting case. They lose money, but just a bit. In Q3 2019 they had a net loss of – $575 000, whilst in Q3 2018 it was – $5,14 mln. In 2019 they started to have operational revenues, some $24 mln as for end of September 2019. They have an equity of $92 mln, and a market capitalization of $743,45 mln, which once again gives a huge ‘market to book’ ratio: 8,08.   

The next position in my portfolio is INCYTE CORPORATION . Those guys, they are dutiful: they have already published their annual 10-K report for the fiscal year 2019. The fundamentals look nice. They have a steady profit, second year on end: $402 mln of operational profit, out of revenues amounting to $1 775 mln. The market to book ratio is hilariously high: $16,9 bln of market cap, denominated over $2,6 bln of equity makes 6,5. Still, the trend in market price is interesting: looks like halfway the ascending horn of the bull. This investment position is maybe not the most illustrative for my successful strategy from the past, yet it seems to be offering some promise. I pass to MACROGENICS INC. The latest financial report available is Q3 2019, which shows a clear financial deterioration as compared to Q3 2018: less revenues, deeper loss. The market appreciates this company moderately, with a market cap of $497,42 mln, denominated 1,95 times over the company’s equity, amounting to $255,2 mln. With all that, the price trend looks moderately promising: even over 1 month there seems to be room for a nice jump up.

Finally, my last investment position in biotech: VIR BIOTECHNOLOGY INC. Their fundamental operations don’t look well: a shrinking revenue, and a deepening operational loss. Still, their cash flow is positive: investors seem to be trusting them, and the whole show was over $46 mln on surplus in terms of cash. Over the last weeks, i.e. since I bought their shares, the price has been decreasing, and yet, on Friday 14th, there seems to have been some bounce-back. In terms of market valuation, this company stands $1,75 bln, which, denominated over their nominal equity of $355,8 mln, spells 4,92. This business is to watch with caution. It looks like a big balloon: a lot of confidence from investors with little apparent substance in the business, but what do you want, that’s biotech.

That would be about all as regards my investment positions in biotech, and so I pass to my two Polish crown jewels at the frontier of digital and show business: CYFROWY Polsat and ATM Grupa. CYFROWY Polsat has excellent fundamentals. In Q3 2019 they made PLN 459 mln ($117 mln) of quarterly operational profit. By the way, in businesses involved with media and cinematic production, the most important operational metric is EBITDA, or operational profit plus amortization, and this one stands at more than PLN 1 bln in Q3 2019. Their equity was PLN 14 155 mln, which, when serving as denominator for their market cap of PLN 5 311 mln gives a market to book ratio of 0,38. Interesting: finally, an investment position with clear undervaluation in the stock market. The long-term trend in their stock price is generally steady growth with temporary bumps. As regards ATM Grupa, they have good operational fundamentals, i.e. a comfortable operational profit, yet they seem to be losing cash at the level of financing activities. Anyway, they accumulate equity at a steady pace, and their market capitalization values that equity at 1,59 of its nominal value.

I pass to my investment positions in energy, and I start with FIRST SOLAR INC. Their fundamentals are sort of hesitantly good: they had positive operational margin in Q3 2019, still it had to offset a deeply negative one in Q1 2019. I found a piece of news at Yahoo Finance, which allows some optimism as for the immediate prospects of their business.  Their market capitalization is $5,83 bln, and denominated over book value of equity ($5,2 bln), stands at 1,12. As for the Polish PGE , they seem to be attaching a lot of importance to that EBITDA metric, as if they were running some show business, not power plants. That EBITDA looks substantial, more than PLN 6,6 bln in 2019 (provisional, unaudited results), yet it is a bit less than in 2018. Their equity – PLN 48,7 bln – is deeply undervalued in the stock market: in terms of market capitalization, it stands at 0,23. Looks interesting for a long-term position.   

Thus I come to the two investment positions, which I can’t help calling but my follies:  ASTON MARTIN, and BLACK DIAMOND GROUP LTD . The fundamentals of ASTON MARTIN look a bite like the beginning of trouble. They spike with their sales in the Americas, and in China, but everywhere else, their sales fall. In 2018, they had a positive operational margin, but in 2019 not anymore. Although their assets keep growing, including their fixed assets, they accumulate debt even faster, whence a decrease in nominal equity: £361,9 mln. With a market capitalization at £961,7 mln, they are overappreciated by the market at 2,66. BLACK DIAMOND makes me understand why I bought it. It is stupid. What I wanted to open a position on was Black Diamond Therapeutics. Black Diamond Group, which I actually bought, was just next on the list. I clicked on the wrong one, and I didn’t notice my mistake. Still, just as in a neural network, errors can lead to something interesting. Here comes the first interesting fact: that company is undervalued in the stock market. Their market cap, at CAD 102,87 mln, is just 0,47 of their nominal equity at the end of Q3 2019. Fundamentally, they display a loss before taxes, still it is a loss after amortization. When we kick amortization out of the formula, Black Diamond made a solid CAD 10 mln of operational profit in Q3 2019.

Just as an additional explanation: I do not perform the same kind of check for my last financial position, the tracker fund Amundi Epra DR ISIN LU1437018838. This is a fund calibrated so as to reflect the performance of listed real-estate companies across Europe, in Borsa Italiana,

Nyse Euronext Paris, Nyse Euronext Amsterdam, and London Stock Exchange. It cannot really be undervalued or overvalued.  

Now, the drums. I mean, the drums start drumming, so as to build up some tension, and I compute the rate of return I had on those investments of mine over the first 2 weeks since opening. In the table below, I sum up the descriptive remarks developed earlier, and I give it a bottom line with the rates of return.

Company Market to book Fundamentals Remarks about price trend – opportunity for growth Rate of return as of February 14th, 2020 (after 2 weeks since opening)
OAT Onco Arendi Therapeutics 2,05 weak no -13,78%
Aprea Therapeutics 14,02 weak possible -21,1%
Frequency Therapeutics 8,08 weak, but improving problematic -1,24%
Incyte Corporation 6,5 strong possible 6,36%
Macrogenics Inc 1,95 weak problematic 8,19%
Vir Biotechnology 4,92 weak possible -29,01%
Cyfrowy Polsat 0,38 strong possible but moderate -1,86%
ATM Grupa 1,59 strong not much, looks more like stable 0,08%
First Solar 1,12 mixed, uncertainty possible 3,09%
PGE 0,23 good, slightly deteriorating possible -13,54%
Aston Martin 2,66 deteriorating no -13,79%
Black Diamond Group 0,47 strong possible -7,82%
Amundi Epra – tracker fund n.a. strong possible 5,21%

A few observations emerge out of that table, as regards my learning by writing about doing things I am supposed to learn how to do. I fail more often than I succeed. Out of the 13 positions I opened, 5 are successful (i.e. bring positive return), and the remaining 8 are failures, at least for the moment. Of course, it is just 2 weeks, and I want to invest on the long range. Longer a time perspective might change things. Still, the science of financial markets says that any given moment, I face a certain aggregate volatility of said markets, and my personal art of survival in those markets consists in keeping myself on the positive fringe of that volatility. The useful assumption is that I never have a full knowledge of the financial market, and my strategy is always the one of trial and error. I need to have many takes at the thing, and my overall success depends on the percentage of those attempts, which I derive positive outcomes from. Right now, my rate of success measured across investment positions (i.e. I do not weigh them yet with the respective amounts of money I invested in each of them individually) is 5/13 = 0,3846. In order to even fathom the outcomes I want to reach, my first practical improvement should be to drive that coefficient above 0,5. When I say ‘drive’ it means that my incidence of success should depend on my choices, not on the volatility of the market. Hence, I need to hedge. I can already see that trackers, such as the Amundi Epra one I already have, are a good way to hedge.

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