The famous Art of War by Sun Tzu sports a thought that the victory in a battle is actually determined before the battle is actually thought.
I must admit, I spend a fair amount of time watching the intra-day activity of the positions I follow and am long on. Such activity is typically not suggested for long-term investors or any investor that is betting on the merits of the company. I have heard rumors that Warren Buffett shuns the use of stock quote tools and relies strictly on SEC filings and industry information to make his investment decisions. I am unsure if that is true, but I hope you can relate to the above illustration, even if it only a rumor.
Watching the tape tick-by-tick has all sorts of negative consequences that can impact investment decision. More often than not, this behavior lends itself to allowing fear and greed in get in the way. Big long-term winners are often sold on unwelcome large dips and fear sets in. A stock that has had a 20% run-up plummets 5% in a single day and in the excitement, the sell order is placed. After all, you never went broke taking a profit. But, regardless, the stock quickly rebounds from its low and then proceeds to become a double or a triple over the next 12 months. On the converse, a stock you are looking to start a position has a break-out day – and thanks to greed, you chase the bid up, only to give in to placing a market order. The stock then pulls back, naturally, and although perhaps the stock does well over the long haul, you restricted your gain somewhat by buying higher than you should. Sound familiar? I think every investor has shared the above experiences in some form at some point.
However, watching tick-by-tick, especially over long periods of time, can provide valuable insight into the future of the company’s stock performance. The key is being able to remove yourself from the fear, greed, and other emotions that can cloud your investment decisions.
Brush Engineered Materials (NYSE: BW)
One of my recent additions to my portfolio, I jumped in BW when it was trading under $40 after it lowered its earnings guidance. Mind you, that my confidence was strengthened by the 485,000 purchase by 14% holder Tontine Capital Partners. Just recently, BW climbed back to over $47 showing a very strong short-term gain and making some of the $40 calls I bought extremely valuable. What happened? BW pulled back sharply, and traded in the $43s. Although the fundamental reason why I added BW has not changed, the pull back certainly eliminated some of the fat paper gains achieved thus far, particularly in the options which have a limited shelf-life. Watching the tape was gut-wrenching and the temptation to exit was strong, especially since 50% of my gains were lost in a single day and I was still very well in the black. However, recognizing the fundamental reason why I bought in the first place did not change, I took a deep breath and resolved that I would hold my position. I actually considered buying more, but that did not happen – though I should have.
Watching the tape over the past couple of days has been inspiring to my long-term confidence in BW at these levels. There has certainly been some volatility – not unexpected in any stock with a relatively small float and active trading environment. A big dip like BW saw lends itself to all sorts of strange variables into the equation. Momentum traders, shorts covering, shorts being scared into covering on small pops, active option contracts, and value investors looking to scoop up shares. This day to day activity can cause some frenetic activity, but among the battlefield, I noticed some very telling signs.
Intraday, BW would certainly have some swings. Nothing dramatic, but it would fall to $43.50, only to run to $44.50, and fall back to under $44. The trend I have noticed the last several days is that during the many up and down swings, volume at the levels tells the truth. There is no doubt that there is some distribution of shares going on out there. After all, BW has had quite a run up the past 12 months and is still up over 100% from its 52-week low, even after its 35% haircut from its 52-week high.
The important observation is that when BW goes on a little mini-run, money flow and buying of stock is strong. The size of the blocks and total volume in these mini-runs is far greater than it is when it takes a breather. My analysis suggests that there is net buying of BW at these levels. There is certainly stock for sale, no question and the blocks for sale come out in mass when the buyers are ready. Then, the buyers take a break and some net selling comes in – only to be met by fierce accumulation. I could certainly be wrong – I am no psychic and the marketplace is an expression of an environment far too complex to understand. However, making an educated investment decision based on rational though, BW is a buy. Exactly why it is being bought up, well, nobody really knows – everyone has a theory.
I liken it to an options contract. For instance, say a buyer (individual or a fund, more likely) thinks that BW is worth $60/share. Basic logic should say that the buyer should just buy up everything in sight, but we all know that makes no sense for many reasons. Why artificially drive the price up before $60 is due? For instance, today, say I believe that BW is going to $60 and I am willing to pay say only $44.25 for BW. If I am a fund managing large sums of money, I have to have a risk formula or reason for doing do. I may be 100% confident in the future of BW and hitting $60, and while I have some ideas of how it will get there, I do not know exactly when or how it will transpire. All I know is that each trading day that goes by is one day closer until it hits $60. So, today, I am willing to buy at $44.25, but say next week, as the $60 timeframe draws nearer (although it is an unknown), I am willing to pay $44.75. The duration is shorter, so I am willing to pay an additional premium to own the shares that I know are going to $60. So, I go in and buy everything in sight up until $44.75, then I back down…the sellers show up and maybe the stock even gets a pop on the incoming volume to $44.90. I patiently then will wait for it to come down below $44.75 to reinitiate my buying. As time goes on, as long as I remain convinced that $60 is the target price, I will be willing to pay more for it. For instance, say BW is at $44.25 and a buy out at $60 is 100% guaranteed to happen (I am not saying it is). Well, in one scenario, the buyout is 12 months away. Why buy now at $44.25? You may be able to do better elsewhere. However, if the stock is at $55 and the buyout at $60 is coming tomorrow, you would be all in.
The above is lengthy, but to summarize, the battle for the future of BW is being decided right now. The action that I am seeing, at least to me, is indicating that there are more buyers than sellers and more people that believe that BW has an upside versus those that believe it has a downside. One day, it will be very likely that the gap will be filled and BW may even be able to go on to even higher levels than it touched on earlier this year. There are no assurances of that, but the profits are being made now by the sophisticated buyers that will not get caught chasing BW up the tree when it breaks out. The activity I am seeing corroborates my fundamental business reasons for liking BW. I like when the stars align.
Ash Grove Cement (Pink Sheets: ASHG)
ASHG has not posted a trade in nearly two months. The spread occasionally moves, which is obviously indicative of some activity taking place, most likely in odd lot transactions. I know how this works because I will often go and buy 1, 5, 10, or even 25 shares – and the trade will never hit the tape, but I do own the shares. The spread, however, will change.
Armed with this knowledge, even when I am merely watching the inside market and taking notice of the change, I am able to learn a great deal about the marketplace out there. The fact that is hardly ever trades really brings some clarity to the table.
Just a couple of days ago, with no volume whatsoever, and after the spread ticked up to $240 x $265, without notice, the spread was $230 x $240. Now, instant reaction is obviously fear, but because I have watched the inside market on this one daily for over 2 years, I know what this means. I am not 100% certain of the specifics, but my strong bullish stance on ASHG (which I make no secret) screams out buying opportunity. Dips in the spread like this are common and I take advantage to nibble and add to my position. Long term, it likely will not matter that much if I paid $5 more per share, but it is nice to get a lower cost basis and to take advantage of such dips to cheaply add to your position. I think investors often forget that buy and hold really needs to be buy, buy, and buy. If it is a great company and there appears to be value in the price being offered, take it. For example, I am glad I bought and hold my first shares of ASHG that I purchased at $160 – but I am even happier that I added more at $180, $195, $205, $210, etc. Of course, in the end, I may be wrong, but only time will tell.
Anyway, seeing the spread at $230 x $240, I knew it would not last long. I added to my position at $240. About 45 minutes later, the spread went to $235 x $240. Within minutes of that, the spread moved to $235 x $243. I actually went to add more at $243, but before the order could even be placed, the spread went to $235 x $250 and then quickly to $235 x $255. I then added a little more at $255. My limit orders at $231, $236, and $240 have gone unfilled, which is typically how this stock works. Good luck buying at the bid or not at the ask, especially if you are working with odd lots. The odd lot approach makes sense as it can be done under the radar. Who knows how much a 100 or 200 share market order would do to the spread – it could be a disaster. I’ve taken out asks before with 5 and 10 share offers.
Today, the spread is $235 x $260. The $255 ask went away the following trading day. I am glad I took the $255 shares when I did – or else I would have had to pay $260. My fundamental reasons for buying ASHG have not changed and I still think it is a value at these levels, so I will continue to add where appropriate. Being attentive to the inside market and learning how this stock behaves afforded me the opportunity to add some shares at an 8% discount to what they are currently fetching – and that fire sale lasted only a few minutes.
Obviously, other people are watching ASHG closely – likely far more closely than I am. I am not sure what happened, but my theory suggests that maybe an employee or a fund wanted out of a handful of shares – bringing the price down. And as usual, someone was there to buy them to keep the marketplace clean. It could have been another fund, though I think it is the founding family doing most of the cleanup work. They will part with a handful of shares here and there for the benefit of their employees and other investors, including institutions and goofballs like myself, but that suggests that a time for these latter groups to sell will come. If you had to bet who is more likely to sell their shares first, would you bet on me or the founding family that has owned them for 100+ years. I feel confident in the future of ASHG and its business prospects (I have written about those already in other articles, so I will spare you that) and I feel even more confident that when those decide it is time to move on from ASHG, the family will acquire those shares to keep the marketplace in balance. The battle for me has already been won. When ASHG hits $300 and potentially $400 – that is when I will remember it is on days like this where there is some form of arbitrage or what not going on that the real money was made.
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