When these high probability opportunities arise, it's best not to let them go to waste. We at PMC recently stumbled upon one of those opportunities. This is the story of a stock we purchased for some of our clients last Friday. Why only some? Because, we felt some of our clients already had enough exposure to the sector that the investment opportunity was in, and there is still a big difference between a high probability investment and a sure bet. With the market there is no such thing as a sure bet.
The company I will be discussing is Noble Corp symbol NE. Noble Corporation provides offshore contract drilling services for the oil and gas industry worldwide. -Source Yahoo Finance. Noble is a part of the PMC30 and thus we are always keeping a close eye on it among many others. During the trading day I am often thinking in the micro scale of time while after it closes it is easier to consider the macro. Every day after the market closes, I make sure to look and reflect on what's been happening. In the evenings, Asif and I discuss the market that day and what we think is likely to occur in the future. It was last Thursday when I brought up Noble. After talking it over, we decided that we'd consider buying it in the morning.
Here I will attempt to give the overall analysis we used in deciding to purchase the stock. There are a multitude of reasons that all converged towards the decision.
Firstly, we liked the industry. The world needs oil. It would be great if the world had plentiful cheap viable alternatives, but frankly it doesn't. And even if it did, it would take a great deal of time to get the world off oil. Humanity is currently trending towards more consumption not less. Meanwhile, it is a fact that oil supplies are diminishing. Also, Noble deals with offshore drilling and President Obama had already indicated that he was open to more offshore drilling in his State of the Union Address.
Beyond that we looked at the fundamentals of the stock. We consider ourselves value investors. That means we want to buy stocks when we consider them on sale. Noble is inexpensive. Why? Well to keep it short, Noble trades at a less than an 8 forward p/e ratio. It has less than a .6 PEG ratio, and it's price to book ratio is below 1.6. We've explained those ratios in previous articles if you are wondering what they mean. It does have debt, but it also has a lot of cash. Its debt isn't really big enough to consider it a deal breaker. Noble also pays a small dividend which is always a nice thing.
After looking at the fundamentals, we consider the technicals of a stock. Noble had closed on a support level and was only slightly above the convergence of multiple supports. The stock had been fluctuating between a channel range since October 8th, 2009. The stock was nearing two major moving averages. Both the 200-day and 500-day moving averages were less than a dollar below where the stock currently sat. The stock hadn't been below the 200-day moving average since July 8th, 2009. In addition, the lowest the price had closed since October 8th was right about the same level where the 200-day and 500-day now sat. When multiple types of support converge you can assume that strengthens the support. It would take something major for the stock price to break through something like that. I've previously explained moving averages in another article if you need to brush up. Thirdly, the stock was riding along the bottom Bollinger Band. A Bollinger Band is based on the 20-day moving average. What it does is it puts one band 2 standard deviations below the 20-day moving average and one band 2 standard deviations above it. In theory, the stock movements should remain within the bands ~95% of the time. Traders often use these upper and lower bands to look for an entry or exit point in a stock. The Bollinger bands can act like support and resistance. That is, traders buy the stock when it is on the bottom band and sell it once it reaches the top band.
Click on the pictures to enlarge.
Other technical indicators also looked good. The RSI, or Relative Strength Index was nearing oversold. RSI is a momentum indicator that compares the size of recent gains to recent losses in an attempt to determine whether a stock is overbought or oversold. The Stochastics also indicated that the stock was oversold. The Stochastic Oscillator is a momentum indicator that compares a stocks closing price to its price range over a 14-day period. Neither of these indicators is perfect, but when both are showing the same thing, it raises the accuracy of their readings.
Lastly, the volume of trading in the stock had been decreasing over the last 3 days. Since the stock had fallen over those days but the volume kept going down, it indicated to us that the selling pressure was lessening.
On Friday morning, March 26th, we watched the stock closely. We ended up purchasing the stock near its daily low and it closed up with a gain for the day. Based on our analysis on Thursday, we thought that there was likely around a downside of 2% and an upside of around 13% based on Thursday's closing price. When we purchased the stock on Friday it ended up being even better odds. That is what you would call a compelling risk reward scenario.
What would we have done if the stock would have broken below where we thought it could bottom out? A lot of traders would see that as an indication to sell the stock. These traders generally do not care about the fundamentals of a stock and are trading solely on technical analysis. Since we primarily view stocks through their fundamental value, we would generally have seen it as a buying opportunity. If we were willing to buy the stock at a higher price, why would that change if it got even cheaper? The stock is currently up ~7% from where we bought it. Not bad for a week's return. Meanwhile, the S&P 500 returned slightly less than 1% during the same period of time.
This was one of those rare opportunities where everything seemed to line up for us. It's not every day that something like this occurs. I write about it in the hopes that if you see an opportunity like this, you will know to take advantage of it. Warren Buffet said, "There are no called strikes in the ballgame of investing. You do not lose a single penny by passing on any given investment. Even if someone else hits a home run with it, doesn’t mean that you are missing out. That said, you will have to swing the bat if you ever want to get anywhere. Just make sure it is a good pitch." Here we had a good pitch and we made sure to swing. Given that you only have a certain amount of money to invest, why waste it investing on bad pitches? Wait for the opportunities to come to you. Obviously, this requires the diligence to take the time to seek them out. If you don't think you are capable or don't have the time or inclination to hunt out good pitches then consider finding someone whom you trust will do it for you.
Update: We exited our clients' positions in Noble on 4/26/2010 at $43.62 and $43.63.
If you would like more information about our advisory services please contact us at panopticmc@gmail.com.
