Roses or Thorns?

I just took a chance and bought a tiny position in Thornberg Mortagage (TMA). I don't have the time to write a full analysis now, but I think that the company is too good fundimentally to be trading this cheap. One kind of debt is killing them, and it's causing margin calls to completely disable them from operating. But the vast majority of their portfolio is made up of prime and super-prime debt, and I think that, if nothing else, a bigger company will be willing to snatch that up at this price.

Bought in @ $1.35.


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Build a Fortune with this Homebuilder

To risk, or not to risk: That is the question.
-Stephen Frankola, author Student Stocks blog.


The debate of risk versus reward is at the core of investment philosophy. Every investment, (even in something as seemingly-safe as a money market fund, as some investors may soon find out) is not without risk; determining the amount of risk versus potential profit determines whether investments are worth making.

I feel as though my following idea has unbelievable upside potential with little limited downside risk.

My company is Hovnanian, one of the troubled homebuilders, and my method is long-term options.

Today I purchased the super-long-term January 2010 calls at the $10 strike price. I picked up a contract at $3.60.

The stock is trading around $7.50 currently.

Here's the reasons why the options are such a great buy:

• I acknowledge that there is some chance that Hovnanian, (or any other homebuilder) could go bankrupt if the housing and credit markets crumble and the US economy enters into an extended recession. Therefore, the stock (and consequently, options) COULD go to $0. I think that the possibility of that is very slim, but if it does, you'll lose $350 with 1 options contract versus $750 with 100 shares of stock.
• The options don't expire for 25 months; by then, if the company is going to recover, it will have recovered. Theoretically, for an investor to break even, it just has to go back to $13.50 by January 22, 2010.
• The upside potential here is enormous. Hovnanian was a $70 stock at the peak of the housing bubble, at $40 within the past year, and at $13 less than a month ago. If the company doesn't go bankrupt (which, I'm betting it doesn't), this thing could easily be $20, 30, or even $40 depending on the size and pace of recovery.

Chart of Hovnanian 5-year stock price; courtesy of Yahoo! Finance

Homebuilding stocks will recover before the entire housing market does; someone who purchased his house within the past few years won't sell it next year for less than he payed. However, Hovnanian, which will be able to buy up cheapened land, can build new houses, sell cheaply, and turn a profit.


During the past quarter, Hovnanian took a huge loss writing down land, homes, and land options. I think that their books are already pretty sterilized; people already know how badly the housing market and homebuilders are doing.


So if Hovnanian's back to profitability in a year, you'll have a $15-25 stock with a year of time value left in your options. If it does bankrupt, you'll have lost less money than if you had purchased equity.


The prospect of making 200% or maybe 500% in two years while sacrificing little is an opportunity that should be seized. The worst may not yet be over for homebuilders, but I'm comfortable with the current risk-to-reward ratio.


Especially since there's a FOMC (Federal Open Market Committee) meeting on December 11th, there's a definite possibility for a quick pop. But my money says, in two years, homebuilders will have recovered significantly. If I'm right, the reward will be incredible.

Last Week Review

Last week was a very big week for me; my positions in my portfolio changed significantly.

I sold my long position in Hovnanian, as it was up 50% in three sessions, to a price that I felt was inflated. (So far, I was correct, as the price has fallen almost $2 from when I executed my sell order).

I was also long in some Hovnanian 12.5 September calls, which thankfully, I was able to sell for a nice little profit. I also had some Abercrombie 80 September calls, which I sold for a little more than break-even.

I'm looking to re-initiate a long position in a homebuilder at some point, once the market settles down a little bit - with earnings being reported from a couple builders this week, the potential volitility is a little more than I am comfortable with. I may or may not choose Hovnanian again; I might choose a safer play. as Hovnanian is probably one of more-endangered builders. However, I still do think HOV will not go bankrupt, and it will trade at two, three, or four times today's price, but I don't know if I want to reintroduce that risk to my porfolio now.

In other news, Syntax-Brillian (BRLC) finally bounced a little bit; I initiated long-term options position $2.50 calls, expiring January), increasing my exposure to the company with some deep-in-the-money, limited-risk calls.

Heelys (HLYS) also finally had a few positive sessions; once again, I reiterate that the company currently looks fundamentally cheap. It's a very long-term hold.

Now that I've pretty much eliminated all short-term plays from my portfolio... its time to get a new one! And for the first time in my life, I'm looking to go short and/or buy puts.

Look at the next post for what I'm thinking about.

Individual Stock Analysis: Hovnanian (HOV)

The housing bubble has been one of the most talked-about topics over the past year. Due to low interest rates and lots of individual and corporate speculation, housing prices artificially blossomed right after the turn of the millennium.

As a homebuilder, Hovnanian (HOV) benefited from this trend. I have a chart below in the article, and take a look at it; the "stock price" is my approximate average yearly price based on real monthly close price over the past 10 years. As you can see, Hovnanian's stock enjoyed an incredible increase in the years up until July of 2005, when it had a monthly close of $70. The stock was trading in the $3-5/share range in the late 1990s, and if you had timed the low precisely, you could have purchased shares for $2.75 each in May 2000, scoring yourself a 25-bagger if you had timed the low and high precisely.

(That's unrealistic, and not the point of this article. But in doing the research for this analysis, those were some interesting statistics I sorted through).

Fundamentally, Hovnanian is very cheap right now. I can't do this analysis based on P/E, because Hovnanian is currently losing money (as homebuilders regularly do during the negative parts of the housing cycles). Plus, according to lots of professional, successful analysts, price to book value is a much better indicator of true company worth.

Below is a chart plotting my approximate average yearly share price versus a mathmatical function of the yearly price/book value ratio. (Price data was obtained at finance.yahoo.com, while price/book ratios were found at Morningstar.com.)

The formula that I used to create a chart that exemplified my point was:

((Book Value x 4)/1.6)^2. The formula allowed the data to be comparable on the same graph. If you'd like a further explanation, click here to download a short explanation in microsoft-word format.

My point is, the share price of Hovnanian has closely followed its book valuation over its history. However, today represents its lowest price/book ratio in the 10-year statistical history, by far. Here is the history, in one-year intervals:

Year	1997	1998	1999	2000	2001
Price/Book	0.9	0.9	0.6	0.8	1.6
2002	2003	2004	2005	2006	TTM
1.7	3.2	2.5	1.7	1.2	0.4

Youcan see that the price/book value is inflated in a great (overvalued/bubble) housing market, while depressed in a tough housing market. However, even during the bottom of the previous housing cycle in the late 1990's, the lowest price/book ratio Hovnanian had was 0.6. Today, that ratio is 0.4. That number is one-third lower than the previous low, which is statistically significant; if the stock was trading at a 0.6 book value today, it would be over $16/share.

So, strictly on valuation, I think that Hovnanian is currently looking fundamentally cheap. However, I think that there are other reasons why Hovnanian is attractive right now. The company does business in at least 19 states, with multiple markets within most states. They create housing developments, but also will build one of their housing plans on an individually-owned lot. This diversified business model will, I believe, help to cushion the effect of this housing bust. Yes, Hovnanian is exposed in some of the worst markets, like Florida and California, where housing is expensive and speculation was rampant. However, it also has operations in communities right around me in Western Pennsylvania, where housing prices are steady, or even increasing.

Hovnanian has already cut many of its losses, writing down land and options in some of the most expensive, volatile markets. I'm not going to naively predict a full housing recovery in the near term, but I believe that Hovnanian has already accounted for many of its liabilities.

Plus, two short-term events could positively affect Hovnanian's business.

First, the "Sale of the Century," a three-day event this past weekend that included price slashes of up to 20% on Hovnanian homes, could generate lots of cash, allowing the company to keep operating normally while removing some of its financial obligations. Though a deeply-discounted home will obviously not yield as much as a full-price home, right now I think it's important for Hovnanian to unload lots of the homes and land that they currently have to pay to maintain. An important feature of the sale is that many of the less-expensive properties will now fall below the price cutoff of a jumbo-mortgage, allowing buyers access to more affordable rates, especially because the lending market has tightened.

Second, the result of the Federal Reserve meeting on Tuesday will surely affect Hovnanian. Surely, a cut will be beneficial, allowing freer access to capital for all. I think that the general market reaction is going to be more unpredictable; it currently seems like either a 25- or 50-basis point cut can be the right or wrong decision. However, I think that the news of any cut, which should occur, will at least be a symbolic gesture that will help restore some confidence.

I have no idea when the bottom of the housing market, and stocks like Hovnanian, will occur. Personally, I initiated a long position in Hovnanian around $15/share, when I thought it was cheap; it's 52-week high is around $40. However, I have no idea if $10 a few days ago was HOV's bottom (that's the least likely scenario), or if it may fall back to $10, or $8, or even less in the coming months or years. However, I think that Hovnanian has the fundamentals to survive this bust; even if it becomes more troubled than it is, I can see a large bank or investor not allowing the company to go out of business.

Hovnanian was probably overvalued at $70 when the housing market was at its over-inflated peak, but I don't think it's a $10 stock either. Based on a rough average price/book valuation of 1.5, that translates to a stock that would be $40 based on today's book value. Even if that estimate is high, it's clear that Hovnanian is clearly NOT a $10 stock.

I don't give financial advice, but if I did, I would not recommend getting into this stock tomorrow morning in anticipation of good news concerning the sale and the Fed. Those are two short-term good-news injections that may temporarily raise the stock price. However, I think the big picture is more important; Hovnanian is trading at a historic low, both in terms of actual price AND valuation, and as the housing market recovers, in 1, 2, or 5 years, Hovnanian's share price should mirror the change.

Disclosure: Author is long HOV.