Over-My-Shoulder Approach To Investment Education

Here we have had a number of comments and emails asking us to explain how we pick stocks.  So far we have not dealt with this topic, feeling that stock-picking was for clients.  There is always a time for an exception.

Educating by Thinking Out Loud

Out of thousands of books read, it is easy to name the one re-read most often, Play Bridge with Reese. We are not putting this on the recommended list, since it would not be helpful to the average investor, but there are some deep lessons.  A generation of current bridge experts grew up with this book.

There is a substantial overlap between the skills required for expert play at bridge and excellence in trading.  It is no accident that many top options traders and investors are world-class bridge players.  Here is a hint:  It is not tea and crumpets.  Success at bridge involves some combination of understanding an abstract language, logical inference, card-play technique, weighing risk and reward, knowing when to bluff, seeing problems from the perspective of others, and maintaining a relationship with your partner.  No wonder it is so difficult!

Terrence Reese

Terrence Reese was a leading player and writer.  His intense concentration was legendary.  During one session at his London club, some players tried an experiment.  A nude model pranced around the room while Reese was playing a hand.  When it was over, someone asked him if he had noticed anything unusual.  “There was something surprising about the play of the spade suit,” he replied.

While Reese’s career was tarnished by a cheating scandal, his innovative “over my shoulder” approach was a big success.  He always set the stage — the opponents, their skill, the form of the contest.  He then described his thought process as he solved the key problem.  Usually there was an enduring lesson at the end.

This approach was widely imitated by other bridge writers.  Anyone familiar with modern literature about poker will also have instant recognition.  Nearly every book these days includes actual hands with detailed thought processes and analysis.

Application to Investing

Since this is such a successful teaching method, why not use it while analyzing investments?  The safe approach would be to take a past winner.  We could then show the brilliance of our analysis.  This would be the pure Reese approach.

We are going to try something that is both riskier and more interesting.  Let us try to analyze an idea in real time.

DryShips

Our case in point is DryShips, Inc. (DRYS).  Our approach will be to describe the basic thesis for putting this on our watch list and identify potential catalysts.  We actively invite reader participation in the discussion.  (Full disclosure — we have a small starter position in institutional accounts.  We are considering various aggressive options strategies and purchase for individual accounts.)

The basic thesis is that the stock price has discounted a major global recession.  This might come to pass, of course, but we are looking for a contrarian play.

Current prices seem to reflect a price perhaps less than the cash value of the company, including a potential spinoff of a drilling subsidiary, and sale of depreciated ships.

What to Watch

The most intriguing feature is the extreme rebound potential if anything improves.  The stock has declined from 11o in mid-May to a current price of 13.

The potential positives would come from four sources:

• Improvement in commercial paper. Many shippers have been unable to secure loans for shipments.  If this changes, the rates for shipping will react.
• China stimulus. If this succeeds, shipping will improve dramatically.  We are especially interested in iron ore shipments from South America to China.
• Any general uptick in the global economy.
• A change in sentiment.

The negatives come from the current climate of negativity, and the economic risks.  A typical example comes from an interesting source, International Shipping News.  Their analysis of the DRYS conference call is quite skeptical:

I haven’t really followed DryShips stock. All of the dry bulk companies are having problems with the BDI recently loosing 90%.

This is why it bothers me when an owner/chairman says “everything is OK” in this article from Lloyds List, Economou allays fears as DryShips shares fall.

DRYSHIPS boss George Economou has confirmed that his Nasdaq-listed company is in good health after a warning-laden share prospectus filing spooked the market, already jittery from the dry bulk crash.

The report emphasizes official disclosures about loan covenants and possible dilution.

Our Take

In the post-Enron, SOX world we cannot expect bullish statements from companies.  The executives must all sign off, and there is plenty of personal risk.  We all need to learn this new environment, where executives cannot and will not make aggressively bullish statements.  The official reports will all have plenty of warnings.

The warnings might prove true, of course, but investors looking for a few holdings that can rebound aggressively must examine the situation more deeply.  That is what we propose to do, in real time, and with some help from our readers.

This is contemplated as a “high-octane” addition to accounts, not the major holding.

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