PWE - Penn West Petroleum

[bizaro86]

Eyeballing it, it's about as low as it's been since the early 1990s, but adjusted for inflation, it's probably all-time lows.

 

That's the thing with commodity stocks. You can analyze and price it as much as you want based on some commodity price, or a probability distribution of prices, but you or management have no control over what the actual commodity price will actually be in the future (and for how long), and there's usually a bunch of operating leverage to it and fixed costs that have to be paid even when you're not making money, so the equity tranche can get squeezed pretty quickly.

 

Which is also the reason why you put it in the sock drawer .....

At a per share cost that is < 1/2 the cost of a cup of coffee - it's not much of a risk.

 

SD

 

I have some great oil stock to sell you. It's only $0.01 per share. They don't even make Canadian pennies anymore, so barely any risk at all. Less than the cost of a piece of gum!

[JRH]

I have some great oil stock to sell you. It's only $0.01 per share. They don't even make Canadian pennies anymore, so barely any risk at all. Less than the cost of a piece of gum!

 

 

It's even better than that, though. You can only lose half a cup of coffee (I could probably do with less, anyway), but upthread he said that if the investment works out you'll be able to buy a house with the proceeds! Talk about asymmetric!  ::)

[Liberty]

Eyeballing it, it's about as low as it's been since the early 1990s, but adjusted for inflation, it's probably all-time lows.

 

That's the thing with commodity stocks. You can analyze and price it as much as you want based on some commodity price, or a probability distribution of prices, but you or management have no control over what the actual commodity price will actually be in the future (and for how long), and there's usually a bunch of operating leverage to it and fixed costs that have to be paid even when you're not making money, so the equity tranche can get squeezed pretty quickly.

 

Which is also the reason why you put it in the sock drawer .....

At a per share cost that is < 1/2 the cost of a cup of coffee - it's not much of a risk.

 

SD

 

This makes no sense.

[Cigarbutt]

Will expect to see more "color" from SD as I doubt that his comments should be read on a first degree level.

FWIW, I think that OBE managed the difficult 2015-6 period painfully but was able to come out with at least some potential.

 

To the question, how worse could it get? I would say potentially a lot worse but, perhaps, what Sharper Dingaan is referring to is the notion of "beta" risk that Mr. Buffett described when he bought Washington Post stock. To compare Washington Post to "Penn West" is a risky proposition but the principle behind the thought process is that once one has determined an intrinsic value for a company, the simple fact that the market price significantly goes down does not automatically mean that your investment is more "risky". In some selected circumstances, it may actually mean that one should buy more then.

 

Bias disclosure: in my humble and limited experience, shares reaching new lows have been a reasonable source of profits.

[Joe689]

I will not speak for SD either but I understand to some extent what he is getting at.  There are hard assets here. Commodity assets.  These assets will always have value.  This company's commodity is oil.  Oil is consumed, finite commodity that happens to be the largest source of consumed energy in the world maybe besides the sun with plants.    It is fair to suggest that these assets are not worth zero.    So the question is, if they are above zero, what are they worth?  We can value these assets by several different techniques.  Several techniques/metrics suggest this is at a extreme level of value.  Lowest of peers metrics, lower than peer transactions, well curves above average.    Just like all stocks, this stock price represents current sentiment.  We all know the current sentiment is at all time low with Canada oil & gas.    Value buyers should be drooling over some of these oil & gas names in Canada.  Doesn't have to be this one. 

 

BTW, Investor day is tomorrow.  What a perfect day to pitch investors when your stock currently has more debt than market cap. 

[SharperDingaan]

Just for the dazed and confused  ;)

 

Coffee reference: A Toronto, Starbucks, freshly brewed coffee (venti) goes for $C 2.45. 2 cups/day, monday to friday, for 46 weeks (4 weeks holidays + 10 stat holidays off) costs $C 1,127 (46*5*2*$2.45). Assume OBE can be bought for $C 0.60 (15% less than current market), and your annual coffee bill alone is equivalent to 1,878 shares ($C1,127/$C0.60). So how material is your investment? (perspective) - divide your share count by 1,878. https://www.menuwithprice.com/menu/starbucks/ontario/toronto/128301/

 

Time: Assume that at some time (unknown as to when) in the next 5 years (pick your own horizon), OBE trades at $C 3.50/share (higher oil prices, lower differentials, M&A activity - all uncontrollable external 'unknowns') - and you sell. The expected price of the house that you would like is $C 500K. At $C 3.50/share you would need to sell 143,000 shares (500/3.50), and at $0.60 each - that would cost you just $C 86K (143,000 x 0.6). Cheap house.

 

Sure it's at an 'uncertain' timeframe, we can't know the future, ties up capital, etc. - agreed! But so is the size of the monthly mortgage payment that you would have to pay, and the length of time it would take to pay it off; neither of which we will have, as we don't buy untill we have ALL the money required  ;D  'Real' versus paper wealth, and walking away when others want to play. Isn't that what value investors are supposed to do?

 

Opportunity: We're just using our ability to time arbitrage, and extract a liquidity discount. Those are real assets in the ground, OBE does not have to sell (folks would just like them to), and if want to do so something in the Cardium you're going to have to talk to them. Price and circumstance changes everyday. So yes please - show me your oil stocks at 10c in the $1!

 

Obviously folks are hurting, and the postings reflect it.

Just different strokes.

 

SD

 

 

 

[Uccmal]

I feel in some small way resposible for the perpetuation of this thread.  OBE has changed dramatically over the years mostly by shrinking.  I got out at least a year ago.  I managed not to lose too much. 

 

General observations.  This company is and has been badly managed for at least the last 10 years.  Successive managment teams have come in and taken big paychecks to "turn it around".  At the same time there is the perplexing situation of Canadian Oil.  Management cant even get around to delisting New York to save money. 

 

The conclusion that I came to well over a year ago was that there were much better managed companies in the Cdn. oil patch.  In fact there are many.  WCP is trading at at least 5 year lows, including the dark days of 2015.  It makes alot of money, is well hedged, and somewhat insulated from the CDN. oil situation. 

 

Why would I even consider OBE which is a take out target at best, and a moribund stock for years to come at worst when I could choose from many names that pay me to wait this out, at ever increasing yields. 

 

Buying OBE at any price is strictly a bet right now on a takeout.  Since everyones stock price is depressed I cant imagine anyone wants to trade their cheap stock for OBE's problems. 

 

Thats just my opinion.  At a certain point there is no sense in fighting the tape. 

[SharperDingaan]

I feel in some small way resposible for the perpetuation of this thread.  OBE has changed dramatically over the years mostly by shrinking.  I got out at least a year ago.  I managed not to lose too much. 

 

General observations.  This company is and has been badly managed for at least the last 10 years.  Successive managment teams have come in and taken big paychecks to "turn it around".  At the same time there is the perplexing situation of Canadian Oil.  Management cant even get around to delisting New York to save money. 

 

The conclusion that I came to well over a year ago was that there were much better managed companies in the Cdn. oil patch.  In fact there are many.  WCP is trading at at least 5 year lows, including the dark days of 2015.  It makes alot of money, is well hedged, and somewhat insulated from the CDN. oil situation. 

 

Why would I even consider OBE which is a take out target at best, and a moribund stock for years to come at worst when I could choose from many names that pay me to wait this out, at ever increasing yields. 

 

Buying OBE at any price is strictly a bet right now on a takeout.  Since everyones stock price is depressed I cant imagine anyone wants to trade their cheap stock for OBE's problems. 

 

Thats just my opinion.  At a certain point there is no sense in fighting the tape.

 

Re full disclosure ...

We also hold a high weighting of WCP, and a good chunk of our OBE holding is funded from house money (original investment already recovered). We're taking very little real risk relative to our potential payout, and we do not have unit holders to answer to.

 

SD

 

[Liberty]

I will not speak for SD either but I understand to some extent what he is getting at.  There are hard assets here. Commodity assets.  These assets will always have value.  This company's commodity is oil.  Oil is consumed, finite commodity that happens to be the largest source of consumed energy in the world maybe besides the sun with plants.    It is fair to suggest that these assets are not worth zero.    So the question is, if they are above zero, what are they worth?  We can value these assets by several different techniques.  Several techniques/metrics suggest this is at a extreme level of value.  Lowest of peers metrics, lower than peer transactions, well curves above average.    Just like all stocks, this stock price represents current sentiment.  We all know the current sentiment is at all time low with Canada oil & gas.    Value buyers should be drooling over some of these oil & gas names in Canada.  Doesn't have to be this one. 

 

BTW, Investor day is tomorrow.  What a perfect day to pitch investors when your stock currently has more debt than market cap.

 

The equity of a company can be worth zero or less than zero even if there are assets that are worth something. If your ROIC is lower than your cost of capital, you are destroying value. A company can be badly managed, have negative margins, high fixed costs, too much debt, assets that aren't worth what they are on the books for, can be unlucky with commodity prices outside its control for long periods, can do bad deals, etc.

 

As I said, this is trading lower than it was trading in the 1990s. That's pretty long-term.

[Liberty]

Just for the dazed and confused  ;)

 

Coffee reference: A Toronto, Starbucks, freshly brewed coffee (venti) goes for $C 2.45. 2 cups/day, monday to friday, for 46 weeks (4 weeks holidays + 10 stat holidays off) costs $C 1,127 (46*5*2*$2.45). Assume OBE can be bought for $C 0.60 (15% less than current market), and your annual coffee bill alone is equivalent to 1,878 shares ($C1,127/$C0.60). So how material is your investment? (perspective) - divide your share count by 1,878. https://www.menuwithprice.com/menu/starbucks/ontario/toronto/128301/

 

Time: Assume that at some time (unknown as to when) in the next 5 years (pick your own horizon), OBE trades at $C 3.50/share (higher oil prices, lower differentials, M&A activity - all uncontrollable external 'unknowns') - and you sell. The expected price of the house that you would like is $C 500K. At $C 3.50/share you would need to sell 143,000 shares (500/3.50), and at $0.60 each - that would cost you just $C 86K (143,000 x 0.6). Cheap house.

 

Sure it's at an 'uncertain' timeframe, we can't know the future, ties up capital, etc. - agreed! But so is the size of the monthly mortgage payment that you would have to pay, and the length of time it would take to pay it off; neither of which we will have, as we don't buy untill we have ALL the money required  ;D  'Real' versus paper wealth, and walking away when others want to play. Isn't that what value investors are supposed to do?

 

Opportunity: We're just using our ability to time arbitrage, and extract a liquidity discount. Those are real assets in the ground, OBE does not have to sell (folks would just like them to), and if want to do so something in the Cardium you're going to have to talk to them. Price and circumstance changes everyday. So yes please - show me your oil stocks at 10c in the $1!

 

Obviously folks are hurting, and the postings reflect it.

Just different strokes.

 

SD

 

This also makes no sense. The share price or how many shares you can buy for a given amount has nothing to do with whether something is cheap or expensive at all. A Berkshire "A" can be cheaper than a penny stock even if the share prices are at extremes of the spectrum.

 

The time comments makes no sense either. "Assume this thing quintuples in the next five years". Sure, anything else we need to assume? Did people assume it would go down 90%+ 5 years ago, or were they saying it was cheap back then too?

 

Sometimes I think you're just trolling us to see who notices...

[Joe689]

I will not speak for SD either but I understand to some extent what he is getting at.  There are hard assets here. Commodity assets.  These assets will always have value.  This company's commodity is oil.  Oil is consumed, finite commodity that happens to be the largest source of consumed energy in the world maybe besides the sun with plants.    It is fair to suggest that these assets are not worth zero.    So the question is, if they are above zero, what are they worth?  We can value these assets by several different techniques.  Several techniques/metrics suggest this is at a extreme level of value.  Lowest of peers metrics, lower than peer transactions, well curves above average.    Just like all stocks, this stock price represents current sentiment.  We all know the current sentiment is at all time low with Canada oil & gas.    Value buyers should be drooling over some of these oil & gas names in Canada.  Doesn't have to be this one. 

 

BTW, Investor day is tomorrow.  What a perfect day to pitch investors when your stock currently has more debt than market cap.

 

The equity of a company can be worth zero or less than zero even if there are assets that are worth something. If your ROIC is lower than your cost of capital, you are destroying value. A company can be badly managed, have negative margins, high fixed costs, too much debt, assets that aren't worth what they are on the books for, can be unlucky with commodity prices outside its control for long periods, can do bad deals, etc.

 

As I said, this is trading lower than it was trading in the 1990s. That's pretty long-term.

 

Good point.  The current trajectory and path of this company is very poor.  If they keep this up, the assets will become the banks assets.    Speaking more concretely, where is the Board of Directors here?    Most of them have been here forever except for the two new large holders activists.  Kernwood and FF.    At least the BOD elected last year to take their pay in shares.    Maybe a sign that things are changing, and the board will actually do their job.  Protect the real equity of the company, the oil, and sell it to someone who has a history of making money from it.....another company.

 

This company needs to be sold and salvage what it left.  There is also the outside chance of a hostile offer considering the deemed PDP NAV adjusted for debt is higher than share price.  They could just turn off the lights and stop capex and return capital to shareholders in the cheapest way possible and this would produce a better return.  But another company buying it, would even produce bigger returns considering the 2P and unbooked land. 

 

 

[Liberty]

Good point.  The current trajectory and path of this company is very poor.  If they keep this up, the assets will become the banks assets.    Speaking more concretely, where is the Board of Directors here?    Most of them have been here forever except for the two new large holders activists.  Kernwood and FF.    At least the BOD elected last year to take their pay in shares.    Maybe a sign that things are changing, and the board will actually do their job.  Protect the real equity of the company, the oil, and sell it to someone who has a history of making money from it.....another company.

 

This company needs to be sold and salvage what it left.  There is also the outside chance of a hostile offer considering the deemed PDP NAV adjusted for debt is higher than share price.  They could just turn off the lights and stop capex and return capital to shareholders in the cheapest way possible and this would produce a better return.  But another company buying it, would even produce bigger returns considering the 2P and unbooked land.

 

Didn't they just recently have a change of management and sell assets and apparently reboot things? How many times in a row can they do that?

 

Seems to me like management and the BOD probably got many millions in compensation over the years and that's what they focused on rather than the equity.

[Liberty]

Re full disclosure ...

We also hold a high weighting of WCP, and a good chunk of our OBE holding is funded from house money (original investment already recovered). We're taking very little real risk relative to our potential payout, and we do not have unit holders to answer to.

 

SD

 

Here's another tip: There's no such thing as "house money". It's all money that you either have (or can sell stock for if it's liquid), or don't.

 

The market doesn't care at what price you bought something. That's just your own anchoring. Once you bought it, all that matters is at what price you sell it and after how long (time value of money).

 

You can sell half of something after it doubled to reduce your exposure or redeploy in a more attractive asset, but that doesn't make the remaining half somehow free money that doesn't count.

 

At the end of, say, 10 years, your return on your starting base of capital will be a number. I guarantee that "house money" will change nothing about that number.

[Joe689]

Good point.  The current trajectory and path of this company is very poor.  If they keep this up, the assets will become the banks assets.    Speaking more concretely, where is the Board of Directors here?    Most of them have been here forever except for the two new large holders activists.  Kernwood and FF.    At least the BOD elected last year to take their pay in shares.    Maybe a sign that things are changing, and the board will actually do their job.  Protect the real equity of the company, the oil, and sell it to someone who has a history of making money from it.....another company.

 

This company needs to be sold and salvage what it left.  There is also the outside chance of a hostile offer considering the deemed PDP NAV adjusted for debt is higher than share price.  They could just turn off the lights and stop capex and return capital to shareholders in the cheapest way possible and this would produce a better return.  But another company buying it, would even produce bigger returns considering the 2P and unbooked land.

 

Didn't they just recently have a change of management and sell assets and apparently reboot things? How many times in a row can they do that?

 

Seems to me like management and the BOD probably got many millions in compensation over the years and that's what they focused on rather than the equity.

 

Yes, about two years ago.  It failed mainly because a mistake of the company hedging all their light oil at $50 18 months out!  They hedged too much, the entirety of one type of their oil,  on a market that we do not even sell on, using simple swaps.  Nothing like betting the entire house on product that you do not even sell.  They lost 100s of millions on this mistake.  Then just went hedges were about to fall off, and we start making money, differentials sky rocket and WTI crashes.  Very bad timing.  And still at this time, we take the hedge loss on WTI coupled with selling our physical product at severe differential, a double whammy.  This mistake caused us to miss all our targets for 18 months.

 

And your right, management and BOD still got paid handsomely.  Our new activist BOD launched a campaign and brought immediate attention to this and called for drastic changes and to sell asset immediately.  Instead of pushing on, they settled for 2 board seats with a standstill agreement.  This was after another large new holder was given a board seat. 

 

So if there is any bright spot, we have a new chairman,  two new activist represented board members, and another 6% major holder Ed Kernaghan (does he have a reputation in canada?).  The other activist, FF, owns a boat load too.    Their argument was that the board was entrenched would not act on behalf of shareholders but instead themselves.  But now after they got on, it still seems status quo.  Might be due to the standstill agreement.    My guess is there is a big divide in the board room.

[Liberty]

Yes, about two years ago.  It failed mainly because a mistake of the company hedging all their light oil at $50 18 months out!  They hedged too much, the entirety of one type of their oil,  on a market that we do not even sell on, using simple swaps.  Nothing like betting the entire house on product that you do not even sell.  They lost 100s of millions on this mistake.  Then just went hedges were about to fall off, and we start making money, differentials sky rocket and WTI crashes.  Very bad timing.  And still at this time, we take the hedge loss on WTI coupled with selling our physical product at severe differential, a double whammy.  This mistake caused us to miss all our targets for 18 months.

 

And your right, management and BOD still got paid handsomely.  Our new activist BOD launched a campaign and brought immediate attention to this and called for drastic changes and to sell asset immediately.  Instead of pushing on, they settled for 2 board seats with a standstill agreement.  This was after another large new holder was given a board seat. 

 

So if there is any bright spot, we have a new chairman,  two new activist represented board members, and another 6% major holder Ed Kernaghan (does he have a reputation in canada?).  The other activist, FF, owns a boat load too.    Their argument was that the board was entrenched would not act on behalf of shareholders but instead themselves.  But now after they got on, it still seems status quo.  Might be due to the standstill agreement.    My guess is there is a big divide in the board room.

 

Seems to me like a levered bet on commodity prices (inherently speculative) with the added risk of provenly ineffective management and the headwind of debt and fixed costs that are eroding value, on top of the assets themselves being depleting (you have to keep drilling), etc.

 

If you're just betting on the price of oil or gas with futures at the CBOE or whatever, at least you only have that variable to take into account, along with how levered you want to make your bet. Here, you have to take into account that the company couldn't even do well when the price of oil went up like 40-50% (before falling again) and time is working against you because at lower commodity prices they are destroying value (negative ROIC). Seems like a stressful position to be in, to be praying for higher oil prices (and I'm not saying it can't do well -- it could spike up tomorrow -- but for all that time that it is doing well, you never know when you'll wake up to the price of the commodity falling off a cliff like these past few weeks, or if management hedges, then maybe the price keeps going up...).

[SharperDingaan]

Re full disclosure ...

We also hold a high weighting of WCP, and a good chunk of our OBE holding is funded from house money (original investment already recovered). We're taking very little real risk relative to our potential payout, and we do not have unit holders to answer to.

 

SD

 

Here's another tip: There's no such thing as "house money". It's all money that you either have (or can sell stock for if it's liquid), or don't.

 

The market doesn't care at what price you bought something. That's just your own anchoring. Once you bought it, all that matters is at what price you sell it and after how long (time value of money).

 

You can sell half of something after it doubled to reduce your exposure or redeploy in a more attractive asset, but that doesn't make the remaining half somehow free money that doesn't count.

 

At the end of, say, 10 years, your return on your starting base of capital will be a number. I guarantee that "house money" will change nothing about that number.

 

Mathematics ......

Buy 100,000 shares at $1/share and an investor has invested 100K. Sell 50,000 shares at $2.00 for $100,000, and what does the investor have? ..... 50,000 shares at an outlay of $0 (the 100K paid to buy the original position - the 100K received on the 50,000 shares sold). Yes the broker statement will show a cost of $1/share, and 50K for the position - but what is the investor actually out of pocket? And if the investor does not need to sell; isn't that investors risk exposure only to their outlay in that risky stock? not it's daily market price gyration. Hence recover investor outlay asap, reduce the risk exposure to zero, & toss the investment in the sock drawer.

 

Think first .....

We make no call on whether OBE is cheap or expensive, we just make a call on whether OBE is likely to be 3, or 5, or 7 bagger over a specified timeframe. Obviously the cheaper OBE is, the more of a multi-bagger we will get if it works out; our risk is that OBE bankrupts (we think OBE would be broken up & liquidated first). But if our outlay is close to zero, we're not particularly concened as to variation in how long it make take to realize on our investment; our real risk is that our end goal was not ambitious enough for the wait incurred - so we think big, to make it worthwhile.

 

Step back....

If an investor bought PWE back when it was a 'real' company & paid an average $C30/share for it (pick your own number); that investors $C56,340 investment in 1,878 shares, is today worth just 2 coffees/day, 5 days/week, for a year. PWE lost it's value a long time ago. But if the investor bought those same shares today (now OBE versus PWE), the most the investor would be out (if it totally fails) is coffee for a year. Hardly life threatening.

 

Do the same thing as every other analyst, and an investor can expect no more than their average result.

To obtain a different result the investor has to take a different approach.

 

SD

 

 

 

[Liberty]

Mathematics ......

Buy 100,000 shares at $1/share and an investor has invested 100K. Sell 50,000 shares at $2.00 for $100,000, and what does the investor have? ..... 50,000 shares at an outlay of $0 (the 100K paid to buy the original position - the 100K received on the 50,000 shares sold). Yes the broker statement will show a cost of $1/share, and 50K for the position - but what is the investor actually out of pocket? And if the investor does not need to sell; isn't that investors risk exposure only to their outlay in that risky stock? not it's daily market price gyration. Hence recover investor outlay asap, reduce the risk exposure to zero, & toss the investment in the sock drawer.

 

Think first .....

We make no call on whether OBE is cheap or expensive, we just make a call on whether OBE is likely to be 3, or 5, or 7 bagger over a specified timeframe. Obviously the cheaper OBE is, the more of a multi-bagger we will get if it works out; our risk is that OBE bankrupts (we think OBE would be broken up & liquidated first). But if our outlay is close to zero, we're not particularly concened as to variation in how long it make take to realize on our investment; our real risk is that our end goal was not ambitious enough for the wait incurred - so we think big, to make it worthwhile.

 

Step back....

If an investor bought PWE back when it was a 'real' company & paid an average $C30/share for it (pick your own number); that investors $C56,340 investment in 1,878 shares, is today worth just 2 coffees/day, 5 days/week, for a year. PWE lost it's value a long time ago. But if the investor bought those same shares today (now OBE versus PWE), the most the investor would be out (if it totally fails) is coffee for a year. Hardly life threatening.

 

Do the same thing as every other analyst, and an investor can expect no more than their average result.

To obtain a different result the investor has to take a different approach.

 

SD

 

More nonsense.

 

It's not math. It's psychology. You're falling for a cognitive bias, a variant of the sunk cost fallacy:

 

https://capital.com/breaking-down-trading-biases-sunk-cost-and-house-money

 

House money is a component of a mental accounting concept. First introduced by the economist Richard Thaler, mental accounting implies that individuals categorise personal funds differently and, thus, can spend and invest them irrationally. [...]

 

People come into trading with an initial capital. If their trades are successful, they accumulate profits as well. Victims of the house money fallacy will treat gains as house money and keep it apart from the rest of the capital. Such traders are prone to take more risks after generating substantial profits.

 

The whole idea of public market investing is that at any moment, you can sell it all and the money's yours. The fun of investing might be the research and analysis, but the goal is always how much money you have at the end. It doesn't matter whether you put certain amounts of money in certain mental buckets in your head, the total dollar amount at the end won't be affected by whether you label something "house money" if you lose it. And if you treat it as "free money" with "zery cost basis", I guarantee you're more likely to lose it than if you feel it's just as yours as any money in your name.

 

Maybe you've been watching too much Jim Cramer?

 

https://www.linkedin.com/pulse/20140929154025-81453962-jim-cramer-and-the-fallacy-of-the-house-s-money/

 

When discussing stocks that have enjoyed strong gains [Cramer] often suggests that viewers take their money off the table and leave “the house’s money” invested. That way, you can’t lose, right? Wrong! Let’s think about this another way. You are in Las Vegas. Surrounded by the glitz and glamour, not to mention some of the best food in the world, you have decided to play blackjack. Lo and behold, you start a winning streak. Your initial stake at the table was $10,000 and through your stellar play you have now amassed the tidy sum of $20,000. Following advice to take your money off the table, you pocket your initial $10,000, leaving you with $10,000, or in other words “the house’s money”, with which to gamble. As it often does, the luck turns and you lose the entire $10,000 back to the casino. What have you lost? You still have your initial $10,000 so, as Mr. Cramer suggests, perhaps you haven’t lost anything.

 

I disagree. The origins of your winnings are irrelevant. It may make you feel better about your losses to say that you only lost back the house’s money but that’s not really true. At any time, you are free to stand up, collect your chips and cash out. That $10,000 in winnings is your money. Once you have amassed that $20,000, the entire $20,000 belongs to you. Labels don’t really mean anything. You have $20,000 and can decide to gamble $10,000 of your money or walk away with all $20,000. [...]  In summary, treat your money as your own. Whether it is profit or principal it belongs to you

 

When you're selling stuff, it just reduces your exposure to both downside and upside. It doesn't make your outlay zero, it just means you took some chips off the table. But the remaining chips are still your money, and if they fall to zero, you've lost that portion of the bet, you can't say "well, I had zero outlay based on my original cost so I lost nothing". That portion isn't any less real than if you actually make money on it -- in that case, you won't say that it's not real money because you had taken out your initial cost from it. And if you keep money invested in something rather than investing it in something else that might do better, that's a capital allocation choice and there's an opportunity cost.

 

As I said, at the end when you look at your results, the dollar amount will be what it is and it won't care about how you label things. Either you'll have good CAGR, or you won't.

 

An extreme scenario to illustrate:

 

You go to the casino with $5 in your pocket. You play for 72 hours straight and somehow win $10 million dollars. You take a $5 chip off the table and keep playing with the rest. You lose it all. You come out with $5. Do you say "oh well, it was only house money, I didn't lose anything" or do you realize that you actually won something and then lost it and that the money was just as real and you could've walked off with it when you had it?

[SharperDingaan]

Just for rebuttal purposes, then we can move on .……

For ease of reference, we have framed our response in casino terminology.

 

If you play in a casino you have chosen to spend $X for Y hours of ‘entertainment’, and to you - the casino is the best use of your time; the expectation is that you will walk out poorer than when you walked in. A retail investor in the ‘market casino’, should have the same expectation.

 

We both recognize that If we walk in with $100, and cash out the $100 as soon as we are able, we will experience ‘free’ entertainment. Agreed, the remaining chips in our pocket have value, and the measurement of that value is Time Weighted Return.  Thereafter, we materially differ.

 

We simply recognize that those remaining chips in our pocket are winnings, and that the ‘market’ was their source; hence the reference ‘house money’. If we subsequently lose those chips through continued play, we will still leave the casino with the $100 that we walked in with. But we do not walk out wealthier unless we cash out MORE than $100 - and permanently put that incremental wealth someplace else (ie: additional house, or mortgage repayment).

 

At any time, we have the option to cash in our remaining chips – or continue to play. What we do, will be governed by 1) whether we need the money today, 2) what and when our likely future monetary requirements will be, and 3) the investment opportunities we have today. If we don’t need the money for many years, we can afford to take the long view, and ignore the interim TWR’s as we don’t need to sell.  Consequently, our risk becomes whether the opportunity bankrupts while we’re holding it, and whether we make enough for the uncertainty we took on; both are entirely consistent with the tenets of the Securities Market Line.

 

We are not OPM, and do not have the marketing imperative to continuously post high TWR’s to retain assets under management. We also do not have to pick the ‘best’ investment; we just need to be in the pack. And because we do not have to do what every Analyst/PM must do - we can earn a different return.

 

OBE may not be loved, but a purchaser today is getting proven reserves at well under the 2P NPV(10) value; and that discount is permanently locked in. Tomorrows prices, differentials, hedges, cost structure, etc., (& therefore profitability) will all be different – but until then the oil remains in the ground, and the purchaser is not paying to store it. And if OBE gets gobbled by someone else …. the purchaser just earns a return sooner, versus later.

 

Obviously not what the shorter-term orientated want to hear, and definitely not what you want to hear if you’re down 40%+. Hence, we’re sympathetic.

 

Just a different POV.

 

SD

 

[Liberty]

???

 

Totally irrational way not only to think about "house money", but about investing in general, which is worse.

[SharperDingaan]

???

 

Totally irrational way not only to think about "house money", but about investing in general, which is worse.

 

No problem, we'll just become rich while you remain poor  :D

 

If your TWR return at the end of this year is +40%; are you really any better off if you choose NOT to cash out, and NOT leave the casino? Yes you're up on paper, but aren't you really betting than the next round on the roulette wheel is ALSO going to go your way? - bet wrong and you lose everything, cash out & you stay rich.

 

If your TWR is -40%; are you really better off cashing out, & going into something else? Yes you're down on paper, but aren't you really betting that by simply STAYING in the casino, at some point in the future, the roulette wheel is finally going to go your way? Especially as you are not out cash until you actually sell - and either withdraw the cash, or reinvest it elsewhere?

 

SD

 

[Cigarbutt]

^I find the above discussion interesting and would like to contribute with 3 points.

 

1-fundamental aspect

 

The issue is contrarian thinking and the question is to also be right.

http://www.capitalspectator.com/commodities-continue-to-dominate-deep-value-etf-ranking/

 

To invest in one or a basket of Canadian oil and gas companies today, one has to factor in very difficult to assess assumptions such as a) global demand related to general economic conditions and b) the "speed" at which the energy "transition" will occur. Another assumption (that used to be secondary if not largely irrelevant but that now is front and center) is the discount issue related to the "delivery" of the product. IMO, the differential is excessive based on a fundamental assessment and may reflect the typical market focus on relatively short term issues. Enbridge Line 3 "progress" will be an important variable to watch. Here's a report that does a good job I think on the more objective evaluation of that aspect:

https://www.investorvillage.com/uploads/83421/files/OILscotia.pdf

 

The author suggests six names, some of which are discussed on this Board. The point here is that if an investor wants to approach this potential opportunity from a basket approach (to include various "torque" profiles to changing oil prices and narrowing differentials), OBE, even if not best in class, could make it on the list.

https://www.investorvillage.com/uploads/83421/files/OILscotia.pdf

 

2-sunk cost aspect

 

The classic definition (there are many variants) of the house money effect implies that one will become more risk-seeking after realizing a gain (this is my lucky day). In his 1990 landmark article, Mr. Thaler, when discussing the effect of prior irrelevant outcomes to present decisions, mentioned that the risk effect was unclear when the previous outcome was negative. Sometimes, people then become more risk averse and sometimes people want to double down. Somehow this is related to the sunk cost effect or the tendency for investors not to sell a security that has gone down in price because of behavioral reasons (not rational analysis). This has happened to me on 2 or 3 occasions in the last 20 years.

 

A "test" which I would now find useful in these situations is to ask myself if I would augment my stake in the "losing" position if there would be a sudden and unexpected inflow of cash to invest (ie an inheritance)?. In SD's case, if OBE was good value at 1.60 and if the fundamental aspect developed in point 1 applies, then staying put at the roulette wheel when the price sits at 0.80 makes sense. If however, given more money available, there would be no rational urge to put more in the sock drawer, I would consider the possibility of a less than optimal value proposition derived from a behavioral bias.

 

https://www0.gsb.columbia.edu/mygsb/faculty/research/pubfiles/1154/thaler_and_johnson.pdf

 

3-house money effect aspect

 

Just want to share an aspect of this which is tricky. In 2009, I decided to use leverage ++, which in fact was like borrowing house money. In 2010 to 2012, despite significant improvements in leverage measures and margin requirements and despite market values not ahead of internally measured intrinsic values by any measures, I decided to progressively sell (instead of letting winners win) in order to essentially eliminate leverage. This was (at least in retrospect) a very costly mistake. The major reason (on top of reading Fairfax and others) was to actively counteract what I perceived to be the risk related to the house money effect (ie to prevent me from maintaining a risk-seeking attitude in the face of rising values). I think it was Keynes who said that, without animal spirits, economic progress would grind to a halt. It's a question of balance I guess.

[writser]

I have to agree with Libery. It’s not an interesting discussion, it’s sanity versus a bunch of drivel and cognitive biases. Chasing losses, gambling with house money, getting back to break even, that’s the stuff losers and idiots do who fool themselves in the casino (or in the bitcoin market or stock market).

 

The history of your net worth is utterly irrelevant for optimal (financial) decision making - even if doesn’t always feel that way.

 

If you are playing roulette and are down $1000 the optimal strategy is: go home. If you are up $2000 the optimal strategy is: go home. Sure, if you are drunk and want to donk away some money and have a good time: go ahead! But do not pretend that that’s a strategic decision to optimize your TWR. Financially seen it’s just fucking stupid, regardless of whether you are up or down so far.

 

Same thing holds for investing in PWE. Your optimal position size depends on your analysis of the company, your risk appetite and macro/portfolio considerations. If you want to have a good time and gamble with an overweight position because PWE has performed well for you so far: by all means, go ahead! But again, please don’t fool yourself by thinking you made a financially rational decision. And even worse: please don’t try to convince innocent readers of this thread because for them these considerations are totally useless.

[SharperDingaan]

Couple of points on sunk costs in this context.

 

Your sunk cost is your cost/share, visible on your broker statement every month.

When we sell for cash, we measure our gain/loss based on that cost price (sunk cost). When we measure 'performance' we use TWR (market value today vs market value at some time point earlier), and cost price (sunk cost) is not part of the calculation.  There is a perception problem: Your TWR for the last 12 months may be +70%, but sell XYZ at < cost price & you still record a loss; per TWR you should look like a hero, per your broker statement you look like a bum. 

 

Sunk cost and outlay are similar but act differently.

Once you recover the sunk cost (outlay) of an investment, the sunk cost (outlay) is zero - & no longer an influence. The problem is what are you now going to do with that remaining position? If you choose to add to it, it essentially tilts the SML upwards for you - by increasing your return per unit of risk (outlay). Example: if you need 143,000 OBE to buy that house, but already have a 43,000 OBE position; you only need to buy another 100,000 OBE at the target purchase price - reducing the outlay (risk) required for that same end return (500K house).

 

To many this is heresy, misleading, or just 'too hard'.

But the fact is we're doing the SAME as everyone else, & ALSO selecting based on company analysis, risk appetite, and macro/portfolio consideration. We just have an existing zero outlay position to dilute against, so we see a different (& better) risk/return opportunity than everyone else. But if it makes sense for us, we will invest - the same as everyone else.

 

To many the obvious practical solution to the issues in the WCSB is a partial nationalization, extended shut-in of a material portion of tar-sand production, a national refinery in the oil-patch, national CO2 re-injection into existing formations, a national tanker car fleet, and national pipelines west, east, and north. Years worth of disruption, construction, and aggregate costs so large that they could only be underwritten by Canada as a whole. Nation building - but obviously, far from popular.

 

And then there's OBE, with all that lovely light oil in the ground, in key formations, and in enough quantity (Cardium) that the solution is going to have to include them. The pay-off isn't going to be in 1-5 years, it's more likely to be in 5-10, and then quite something. And available at how much of a discount to the current 2P NPV(10) value?

 

Obviously, each to his own.

We just choose to invest differently.

 

SD

 

 

 

 

[writser]

Once you recover the sunk cost (outlay) of an investment, the sunk cost (outlay) is zero - & no longer an influence.

 

It shouldn’t have been an influence beforehand either... Hence the name: SUNK costs. You are literally advocating using a behavioral bias to influence your investing decisions. That’s just terrible.

 

Maybe this line of thinking (first “recovering costs” to “gamble with house money” makes you sleep better at night and sure, that’s fine. If so, by all means keep doing it. But it is just bogus reasoning and in the long run decisions made this way will be detrimental to portfolio returns.

[SharperDingaan]

Once you recover the sunk cost (outlay) of an investment, the sunk cost (outlay) is zero - & no longer an influence.

 

It shouldn’t have been an influence beforehand either... Hence the name: SUNK costs. You are literally advocating using a behavioral bias to influence your investing decisions. That’s just terrible.

 

Maybe this line of thinking (first “recovering costs” to “gamble with house money” makes you sleep better at night and sure, that’s fine. If so, by all means keep doing it. But it is just bogus reasoning and in the long run decisions made this way will be detrimental to portfolio returns.

 

This is no different to everyday capital budgeting and selecting projects based on shortest payback period, when capital is the limiting factor. We just end up with 2 porfolios and a bar-bell approach; an 'A' portfolio of risk-adverse T-Bills (our own capital contributions over time), and a 'B' portfolio of risk-on unrealized equity gains/losses (stub positions). As long as we fund from the 'A' portfolio under payback period criteria, and systematically invest & withdraw from the 'B' portfolio over time under standard investment criteria; our pile of T-Bills will keep growing, and we will sleep better and better through time. The B portfolio also never exceeds a maximum X, ensuring that we systematically take $ out of the casino, and permanently increase our wealth.

 

We could have simply put LEAPS in the B portfolio, & just been done with it. Holding a stub equity position versus a LEAP (assuming availabilty) allows us to avoid the time decay.  Obviously, not for everybody, and just a different approach that has worked very well for us over time.

 

SD