Thursday, March 17, 2011

RSY XXX: Buffett makes a call, Unload LZ. Buy DLN 200 @ $47.01

The events in Japan has shown that there are always risks and uncertainties in any investment. Just think what the value of time-share condos at Ōkuma near the Fukushima Dai-ichi Nuclear Power Plant is about now. While insurance can compensate individuals for these risks and uncertainties, they do not negate the costs to society when tragedies do occur. And of course no costs can be completely analyzed without understanding the full extent of human lives lost and the damaged/destroyed lives of the survivors.

Along with the risks associated with any tragedy, they also provide opportunities as the economy changes to adapt to new demand structures. One area that could be lucrative potentially, as Japan reconstructs much of their coastal cities, is commodities and basic materials. With the nuclear industry getting hit on all sides then it is logical that our holdings of ARLP is doing nicely since March 11.

Irregardless of the timing, Berkshire Hathaway has decided to purchase our holding of LZ for cash of $135.00 per share. If you held it long, without writing a covered call, it certainly seems to be the time to unload with a large capital gain now. Interest rates being low then the arbitragers have narrowed the gap between offer price and market price to as low as 70 cents difference. Not withstanding the ambulance chasers and their delusional investors (Law Office of Joseph Klein, Faruqi & Faruqi, Law Offices of Vincent Wong, Ryan & Maniskas, Law Offices of Howard G. Smith, Law Office of Abe Shainberg, etc.), most recognize this as a solid deal that is not likely to be adjusted up or to fall apart. That is, investors are not bidding above the offer price as it did at times with other mergers, and shorts are backing off of it also as recognized by Kapitall at 20 Stocks Seeing Unusually High Trading Volume, Decreasing Shorts. S&P also recognized the value as being close to realistic as they downgraded LZ from a Buy to a Hold.

Forgive my ranting, but if investors really thought that LZ was worth $148/share (as Thompson/First Call stated) then there is no way any rational investor would allow it to drop to below $104 last Friday, March 11th. Any rational investor seeing a discount of nearly 30% should jump at the chance as soon as possible with as much gusto as possible.

Selling the covered call has limited our upside potential, but during the down days it limited our losses and for that it was good. Now we need to unwind our trades while maintaining the gains as much as possible. Along with the decreased interest by the short players, option players have dropped the price so that the time value of the options are nearly zero. When RSY recommended the sell of the covered call, the theoretical value was below what we sold it for and now the selling price is about half the theoretical value at $30.86. The JUN-11 $120.00 CALL has been trading in the $14.10 to as high as $15.80. So the plan is to enter a buy to cover, limit order at a price of $14.10 which signifies a loss of around $5.50 per share before transaction costs. As soon as that trades, RSY recommends a sell of LZ at a limit price of $134.01 or whatever seems reasonable at the time. Good luck.

Even before this recent spat of selling for the RSY portfolio, we were looking to find ways to diversify our holdings across market caps and segments of the economy. One way is to use ETFs since they are a basket of equities. They are much more diversified than individual investors normally get that hold stocks of independent companies. For our Silver Level subscribers, we offer ETF Ratings Reports on hundreds of ETFs. Two that are promising candidates are LargeCap Dividend Fund (DLN) and Total Dividend Fund (DTD) both provided by WisdomTree, and both are rated by Sabrient as Attractive with a score of 69 and 59 respectively. Taking a look at the chart below for DLN of sector concentrations, we see a fairly well diversified portfolio to start with.

This fund is underexposed to three sectors: Basic Industries, Consumer Durables, and Transportation. While being somewhat diversified across sectors, there are also some gaps here. On the other hand, this fund is not overexposed to any particular sector and is therefore not unduly weighted toward any particular segment of the economy. While this fund is not significantly overexposed to any particular sector, it does have some sectors that are underrepresented in its holdings. This means that there is a degree of sector based diversification, but also some expectation of increased risk due to the missing components.

The passage above was from the DLN ETF report about diversification. This does provide areas that we may want to get more exposure in especially the basic industries. Not mentioned above, but important for RSY is that both ETFs are more weighted toward "mega caps" with more exposure to quality blue chip stocks. This should contrast nicely with Sabrient's emphasis on small-cap and mid-cap choices so far for RSY.

RSY recommends a buy order of 200 shares of DLN at a limit price of $47.01 (good for the day).




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