November 14, 2007

Every Man a Speculator (Including Me)

Your science cannot take account of her;
She controls, takes decisions, executes them
In her kingdom, as other gods do in theirs

Her permutations go on without truce;
Necessity ensures that she is rapid;
So you no sooner have a thing than you lose it.

-- Inferno VII: 85-90

DANTE’S WORDS about the demiurge of Fortune resonate still today, although I daresay I now find myself at the mercy of another VIXen. You see, in a moment of weakness -- well, more precisely a moment of hubris, vanity and overconfidence – on Tuesday I became what I have most abhorred. Yes, I have become a … speculator.

You see, on Tuesday morning I was at home relaxing and reading the financial press, and I came across a story about the great tumult surrounding shares of the E*Trade Financial Corp. (NASD: ETFC), the on-line brokerage and banking institution. For those of you unfamiliar with this grand saga, you should know that on Friday night, an analyst for Citigroup proclaimed that E*Trade was in most dire straits due to an asset portfolio it holds.

This portfolio contains some $3 billion worth of asset-backed securities, including some $450 million in dreaded collateralized debt obligations, as well as some bullshit securities based on second mortgages. These nasty little instruments are what’s responsible for the turmoil in the credit markets, because these formerly swell investments have turned to crap. They’ve turned to crap because people have realized that bunches of the mortgagees basically engaged in fraud to get the loans. Also, the loans are cruel and designed to squeeze every penny out of the borrowers. This would be fine except the borrowers don’t have the money to make their rapidly-rising payments, leaving the lenders stuck.

Anyway, the Citigroup analyst basically said the company was screwed because of this, forecasting a 15 pc chance of the firm going under. This prompted the company’s shares to crash on Monday and by Monday night they were off 59 pc and trading somewhere about $3.55 a share. Thus, I had a “What’s up with that?” moment.

The way I saw it, this was a complete overreaction.* So the company’s going to have to write off some of its CDOs. So is everyone else. Besides, at $4 or so, that gave ETFC a P/E Ratio of … three. Yes, three. Its expected forward P/E Ratio was 12. The company also said it could write off $1 billion of that portfolio and still be on solid ground. I mean, it was so out of whack that the company’s cash accounts were worth more than its market capitalization, meaning that if someone came and bought the whole stupid company right then and there, the buyer would essentially get paid to do so.

As a result, I bought ETFC after about ten minutes of quick investigation.

After doing it, I thought I needed a shower. I mean, I could FEEL the disapproval from my father, who has spent the last 31 years informing me about the importance of avoiding speculative traps, why one ought buy and hold, why one ought not act before prudently evaluating a situation. About the only saving grace was that I had bought a trifling** amount of the stock, with a bit of the capital scraped up from the odd dividend here and there and the leftover bits of cash from other investments.

Thus, the way I saw it was that if the company did tank, I’d be out a trifling amount of cash. You never want to lose money, of course, but if I did, it wasn’t like I would have put my retirement at risk. The upside was that the stock could well rebound and have a bright future. Arguably, there was an 85 percent chance of that happening, based on the gloomy analyst’s report. Besides, E*Trade has a strong brokerage business, so what the hell. I bought in at about $4.21.

A while later I checked back and the bloody thing had skyrocketed to like $4.70 and by the time I got in to work it was up to $5.42. It closed at $5 but rebounded in after-hours to $5.24. That’s twenty-five percent in a day. And despite the small actual gain – it was truly marginal – I had a spring in my step the whole bloody day as a result. I mean, I was really and truly happy. On one hand it was completely ridiculous but on the other hand I felt like I really got in, if not on the bottom floor, on the second.

True, the trading was absolutely insane. I spent some time watching it in awe, as giant blocks of $100,000 and $200,000 worth of shares were bought and sold and the ask price slowly rose up. At the end of the day, some 250 million shares had been traded, which is like HALF the company’s shares. So clearly day traders and speculators everywhere were in on this, and that was undoubtedly fueled due to speculation about a merger or takeover and the fact Jim Cramer said reassuring things about the company***. Conveniently, all these things happened after I bought the shares.

Of course, I am acutely aware this could all go to hell and the company could vanish and I’ll be left with two cents on the dollar and E*Trade will go the way of**** Plus, God knows what the speculators will do to the thing on Wednesday. But I do plan to keep the shares for a long time coming. On Tuesday, I got in at the bottom, and I’ve either scored a huge coup or caught a falling knife. We shall see how it turns out.


* Efficient market my ass.

** In investing terms, a “trifling” amount is in the three figures. This is below a “small” investment in the four figures and a “rounding error” in the two figures.

*** BOO-YAH!

**** If that actually happened, that would make for an excellent commercial some day, wouldn’t it?

OBLIGATORY DISCLAIMER: OK, so I bought a few shares of ETFC. This does NOT mean you should as well, if only because the price has gone up and you’ve missed your opportunity to get in at the ground floor. Investments can and do lose money, and God knows I’m taking the risk of that happening here, especially if Cramer spills soda on his shirt and hits the wrong sound-effects button and suddenly everyone watching him sells the thing short. You should always talk over any investment decision with an actual professional and carefully review all paperwork explaining potential risks before investing. And for the love of God, don’t buy those overpriced proof sets of commemorative coins.

Posted by Benjamin Kepple at November 14, 2007 12:06 AM | TrackBack
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