THE DARK HORSE HEDGE UPDATE
By Scott Brown at Sabrient, and Ilene, at Phil’s Stock World
The Dark Horse Hedge enters the week of July 6-9, 2010, mostly in
cash, and with a portfolio tilt of 67% SHORT and 33% LONG, as the
S&P 500 is trading below both the 50 and 200 day moving averages.
With the less than inspiring economic data now in the rear view
mirror, the market should find some support and look towards the
earnings season. The SPX ended the week at 1023 with the nearest
technical support being at the September 2009 levels of around 995.
This doesn’t mean the market will trade down to those levels, or not
trade higher, in the short term. It might trade higher, but it is
clearly in a downtrend for now which is confirmed by lower lows and
lower highs on the bounces.
Since June 18, the market has more or less dropped straight from
1118 to 1023. Heading into earnings season, the market continues to be
technically weak allowing us to pick up XRTX and TEO at value prices.
XRTX announced earnings after the bell Wednesday and beat estimates of
$1.35 to earn $1.39. More importantly, it guided towards the high end
of earnings and revenue estimates for the upcoming quarter.
Nevertheless, XRTX traded lower on Thursday and Friday to close at
$12.22 giving it a forward P/E of 4.24 which helps enable XRTX to rank
#2 on Sabrient’s Value Change Up (VCU) ranking scale for the coming
week. Seagate (STX) and Western Digital (WDC) are both highly ranked as
well, reflecting undervaluing of the Computers & Peripherals group
as a whole. Historically, hard disk drive sales are stronger in the
second half of the year and this could be a catalyst for a turn around
in the group. Our other LONG position TEO lost 1.03% since we entered
it on Thursday’s open and remains in the Top 10 Sabrient VCU ranks.
We initiated four SHORT positions in accordance with our SHORT tilt
which all performed as expected in the down market. HUSA shed another
-5.48%, JOE fell -2.48%, USG -1.24% and AMAG -.85%. Nothing has changed
in the market or with these four positions that would change our
opinion heading into the week.
One of Dark Horse Hedge’s main premises is that daily market
direction is very hard to predict. Consequently, we always attempt to
hold LONG positions that are the highest ranked companies based on
Sabrient Outlook scores and SHORT positions which have the lowest
rankings. Theoretically, this strategy will enable our portfolio to
perform well in both up and down markets. The tilt accounts for the
technical trend of the market and helps us achieve higher returns by
being weighted in the direction of the trend. This strategy also allows
us to be flexible and adjust long and short weightings as the market
We will provide updates during the week as we see opportunities for position entries and exits.
Note: we initiated six positions (two long, four short) in the new
Dark Horse Hedge Portfolio last week. In case you missed it, here’s the
The Dark Horse Hedge
Scott Brown, Managing Director – Retail Division at Sabrient, is
launching a newsletter with Phil’s Stock World based on the highly
successful and popular Investors’ (H)Edge product. The Dark Horse Hedge
newsletter is a Long/Short retail portfolio taking advantage of
technical market trends to tilt the balance of LONG vs. SHORT in
bearish, bullish or range bound markets for added Alpha (the measure of
return on a risk adjusted basis). Long and short equity positions taken
in The Dark Horse Hedge portfolio will be chosen using to Sabrient’s
rating system, which is primarily based on fundamental criteria.
Because the stock positions will generally be held for intermediate to
long periods, these positions are ideal for using with option
strategies taught by Phil Davis, of Phil’s Stock World.
The Dark Horse Hedge (DHH) newsletter will follow a number of
guidelines in an attempt to minimize systemic risk, or “Beta.” Beta is
a measure of the volatility of a portfolio in comparison to the market
as a whole. To keep beta low, the DHH portfolio will have both long and
short positions. Consequently, dramatic moves in the market will always
be in the direction of at least part of the portfolio.
Using Sabrient’s rating system, we will focus on being long high
quality stocks, and short low quality stocks. Long positions should
fare better than average during market selloffs. In contrast, the short
positions, selected from the lowest ranking stocks, should perform well
during selloffs. These stocks are also expected to underperform higher
quality names in a stronger market. This strategy is designed to
balance the goal of attaining Alpha with the desire to keep Beta
We will follow this list of guidelines in building the DHH portfolio.
1. When fully invested, the Portfolio will have 24 positions. However the portfolio may not be fully invested.
2. Tilting (or weighing) of the portfolio will be based on the
position of the SPX relative to its 50 and 200 day Moving Averages
- If the SPX is below both its 50 and 200 day MA the portfolio will
be tilted SHORT with 67% SHORT and 33% LONG (i.e. up to 16 SHORT and 8
LONG positions when fully invested)
- If the SPX is between its 50 and 200 day MA the portfolio will be
balanced equally LONG and SHORT (i.e. up to 12 LONG and 12 SHORT
positions when fully invested)
- If the SPX is above both its 50 and 200 day MA the portfolio will
be tilted LONG with 67% LONG and 33% SHORT (i.e. up to 16 LONG and 8
SHORT when fully invested)
3. A hysteresis will be used around the tilting to avoid whipsaws.
4. 10% will be maintained in Cash for swing trade alerts. Exceptions
may be made to devote more than 10% of the portfolio’s value in in
swing trades when presented with compelling opportunities.
5. Each position will be monitored daily with alerts for changes on the next trading day open.
6. Portfolio assumes a $100,000 starting account using leverage of the LONG positions to SHORT.
Positions are chosen using the Sabrient Outlook Score and Top and Bottom ranked stocks.
The S&P is currently under both the 50 and 200 day MA so we are starting with a short tilt of 4 SHORT and 2 LONG.
Here are the initial positions we are going to take to achieve a
bearishly weighted, partially invested portfolio. As we follow the
market moves over the next week, we will begin adding positions to fill
out the portfolio.
For each position, we will allocate 7.5% of our total portfolio
value to each of the below positions. Click on stock symbols for
Sabrient’s research reports.
The St. Joe Company, JOE, $23.16
Sabrient rating: Strong sell
The St. Joe Company, together with its subsidiaries, operates as a
real estate development company in Florida. The company operates in
four segments: Residential Real Estate, Commercial Real Estate, Rural
Land Sales, and Forestry.
As St. Joe’s is a major land owner and property developer in
Northwest Florida, about 70% of St. Joe’s properties are within 15
miles of the “now imperiled coastline.” It doesn’t matter that they
purchased 577,000 acres at a low price. The bottom line is that
contractors have already found tar balls on St. Joe’s beaches and
nobody wants that kind of beachfront property.
USG Corporation, USG, $12.08
Sabrient rating: Strong sell
USG Corporation, through its subsidiaries, engages in the
manufacture and distribution of building materials primarily under
SHEETROCK, DUROCK, and FIBEROCK brands worldwide.
On June 24, Moody’s Investors Services downgraded two credit ratings
of building materials company USG Corp citing a dim outlook for the
building sector. The ratings agency said that USG has low capacity
usage rates at its gypsum manufacturing facilities. It believes that
demand for gypsum board, used for walls and ceilings, and other
building materials won’t be enough for USG to cover its intermediate
term interest expenses.
USG has been losing money for several years and the losses are
expected to continue for several more years. The bad news from the
housing industry over the past week does nothing to improve the outlook
for USG, and I think USG is more likely than not to continue to trend
back toward its 2009 low, which was below $5.00 a share.
Houston American Energy Corp, HUSA, $9.86
Sabrient rating: Hold
Houston American Energy Corp. engages in the exploration,
development, and production of natural gas, crude oil, and condensate.
It primarily focuses on properties located in the United States. Last
Monday (June 28), Sharesleuth.com
published an article about HUSA expressing a number of concerns,
including concerns about the management team’s history, questionable
valuations on the Columbian estimates, and significant ties to people
with prior SEC troubles. From Sharesleuth.com:
A SPECTACULAR DEAL?
The gains are linked largely to Houston American’s deal last October for a 25 percent interest in a Colombian oil prospect controlled by SK Energy Co., one of Asia’s biggest producers, refiners and marketers.
Houston American said in an investor presentation and subsequent Securities and Exchange Commission filing that the prospect was estimated to hold anywhere from 1 billion to 4 billion barrels of “recoverable reserves.”
The latter figure exceeds the official proved and probable reserves for all of Colombia, and stands as one of the most audacious claims by any of the energy companies operating in that country.
Houston American did not cite a consultant’s report or any other
independent study as the source of its estimate. Nor did the company
offer any qualifiers, such as the percentage of those reserves it has a
reasonable certainty of producing…
Regardless of Sharesleuth’s allegations, the company is trading at
81x earnings in a business that its peers receive 22x valuations. All
of this leads me to believe that HUSA is overvalued at $10/share.
AMAG Pharmaceuticals, Inc., AMAG, $34. 35
Sabrient rating: Strong sell
AMAG Pharmaceuticals, Inc., a biopharmaceutical company, engages in
the development and commercialization of therapeutic iron compounds to
treat iron deficiency anemia (IDA) in the United States, Europe, and
Applying Sabrient’s rating system, AMAG scores very poorly on
several key rating measures. Specifically, a fundamentals score of 4.5
out of a possible 100 (industry average 52.1), measuring the company’s
financial health, a balance sheet score of 39.2 out of 100 (industry
average 68.8), measuring a company’s liquidity and debt issues, and a
value score of 39 out of 100 (industry average 51.6), which measures
the company’s stock price against its intrinsic value. These factors
combine to suggest AMAG as a good short candidate.
Earnings and Revenue Update: For the quarter ended March 31, 2010,
AMAG Pharmaceuticals reported earnings of $-23.1 million or $-1.15 per
share compared with $-18.4 million or $-1.07 per share for the prior
quarter and $-26.4 million or $-1.55 per share for the same quarter one
year ago. Revenues were $13.3 million for the quarter ended March 31,
2010 compared with $13.1 million for the prior quarter and $1.0 million
for the same quarter one year ago. Last twelve months’ earnings were
$-5.06 per share compared with $-5.23 per share a year ago. Last twelve
months’ revenues were $29.5 million compared with $2.3 million a year
AMAG has the dubious distinction of being on the Top 10 highest
short-interest companies at 30.2%. Analysts project a loss for the year
of $3.88/share and $2.02/share in 2011 which is the “good” news.
Estimates for the upcoming quarter have been revised downward from
-$.76 to -$.97 in the last 30 days.
Xyratex Ltd, XRTX, $14.15 (trading higher after hours)
Sabrient rating: Strong buy
Xyratex Ltd provides modular enterprise-class data storage solutions
and storage process technology. The company designs, develops, and
manufactures enabling technology that supports storage and data
Xyratex Ltd (XRTX)
reported a quarterly profit that beat market estimates as it benefited
from strong demand for its storage products. Net income for the second
quarter ended May 31 was $43.7 million, or $1.39 a share, compared with
a loss of $9.6 million, or 33 cents per share, a year earlier.
Excluding items, earnings were $1.49 a share. Revenue rose 134 percent
to $455.9 million.
Analysts expected earnings of $1.35 a share, excluding exceptional
items, on revenue of $430.3 million, according to Thomson Reuters
I/B/E/S. For the third quarter, the company forecast earnings of 87
cents to $1.16 a share, excluding items, on revenue of $385 million to
Telecom Argentina S.A., TEO, $16.43
Sabrient rating: Strong buy
Telecom Argentina S.A., together with its subsidiaries, provides
telephone services to residential and corporate customers in Argentina.
It operates in two segments, Voice, Data, and Internet Services; and
Wireless Telecommunication Services.
TEO operates at a 22.6% profit margin compared with the industry
average of 2.95%. Additionally, the current P/E is 8.67 while the
industry trades at a multiple of 15.95. Lastly the PPE (Projected P/E
based on 5 year forecast) is .75 against the industry average of 1.55.
So as a value purchase we are adding TEO at 1/2 the price of its peers.
TEO’s earnings were up more than 30% for 2009 and are expected to be up
nearly as much this year.
Key economic data will come out Thursday and Friday which will
determine the short-term market direction. The S&P broke key
technical support levels at 1040 today as the Dark Cross formed with
the 50 day MA crossing the 200 day MA downward. This pattern has not
proven to be as predictive of a bearish sentiment occurring when the 50
day MA crosses the 200 day MA in an upward direction but is worth
noting. There are no clear support levels until around 980 on the
S&P so the bearish tilt SHORT is in place.
Disclaimer: This newsletter is published solely for
informational purposes and is not to be construed as advice or a
recommendation to specific individuals. Individuals should take into
account their personal financial circumstances in acting on any
rankings or stock selections provided by Sabrient. Sabrient makes no
representations that the techniques used in its rankings or selections
will result in or guarantee profits in trading. Trading involves risk,
including possible loss of principal and other losses, and past
performance is no indication of future results. More Sabrient
Stock selection by Scott using Sabrient‘s analytical tools.
Read more about Sabrient’s newsletters here.>
Authors have no positions in the above-mentioned stocks.