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Now the question in my mind is, should one look at the 2% outperformance and say, 'ehh, not bad, but it's such a short time, just buying the S&P index would be simpler, why waste effort searching for individual stocks?"

Or can one postulate, "The reason why the S&P shot up so much is because we can now find negative enterprise value stocks in bulk?"

I welcome any comments!

I would vote neither. :-) I was somewhat surprised given the time frame that your basket of stocks didn’t do much better and I think I might know why.

I believe this market downturn is fundamentally different than the last time (When the Green Gene Stocks board came into existence and proved to work so well) during the “tech wreck.”

During the “tech wreck” you had many companies who were effectively priced to go out of business due to extreme negative market sentiment, despite in many cases the companies having large cash reserves that made that assumption a very low risk event. This allowed investors to bet knowing they would/could profit from any of 3 scenarios, i.e. improved market sentiment lifting all boats, company specific improvement or a more rational valuing of the cash on their books. If you hit one you have a successful trade, hit two a very successful trade and hit three and you have in all likelihood a multi-bagger.

What I believe is different this time is, because the downturn is finance related, in all likelihood cash rich company’s valuations are being propped up even though it may not seem so with their depressed price. If I am correct in my thesis than this would explain your list of companies basically tracking the S&P with allowances for any fundamental changes to individual companies.

I believe the greatest opportunities this market will give you lies with companies that are being irrationally priced because they are caught up in the credit crisis. Many of these companies will indeed suffer permanent some damage due to the crisis, but this is an entirely different situation than pricing them to go out of business or inflicting shareholders with a complete loss of equity as the market has done with many of them.

Two examples,

ACAS….Few companies have been trashed any worse than ACAS. Their price was driven below a buck despite reporting a NAV of around $15 (That’s off the top of my head) Why? Well it’s a long story but the biggy is, in addition to the economy and/or normal worries that one would have over the performance of their companies and their investments, a series of events has led them to be in default on their debt covenants. So now they “could” be forced into bankruptcy. Scary stuff right? Well not exactly IMO because the bankruptcy in itself would keep their creditors at bay buying them the time to work through their problems and you could make any number of negative assumptions about them carrying stuff on their books too high or distressed sales and still end up with plenty of value left over for shareholders in the end. (They are only leveraged one to one so for example a distressed sale of 20% would effectively cost shareholders 40% on a asset that was carried on the books for around 20 times what the shares were selling for.)

FMD…same story only different. :-) Tons of book value in the residuals, while they were trading below a buck with sufficient cash to see them through a year or two. Sure you had to overlook the messy little fact that they have been effectively out of business the last year and a half and with no end in sight going forward, but you also could be reasonably confidant that things weren’t going to get a whole lot worse any time soon. This set up a situation where any good news for the company and/or improvement in the market over the following two years was likely to pay off very well.

There are plenty of others out there each with their own unique stories, but the point I am trying to make is while the market is highly efficient at telegraphing which companies are very exposed to being trashed in an environment such as we find ourselves it is horrible at picking the ultimate number of fatalities. If I can pick a basket of stocks that the market has priced for complete failure and it only gets a few of them right I am likely to make some extraordinary returns.

So far, so good. :-)

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