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Today, March 4, 2024 just after 2PM, Norfolk Southern Railway’s stock surpassed $260 per share. The Value Investment Fund proceeded to sell the stock and net $259 per share after paying a $1 per share transaction fee.
The fund is proceeding to sell several of its investments in order to clear the Margin Account per the terms of the special loan account. Terms require the Investment Fund to completely pay all monies borrowed at least once a year to protect the lender’s position. In effect, the Fund must carry a ZERO balance for 14 days in accordance with the terms. Renewal date is 03/10/24; thus the Fund must clear the margin account and then wait until almost month’s end to borrow again.
The Margin Account requires a 2% closure fee on the original borrowed amount. In this case, total capital borrowed was $60,104 over two tranche purchases. Therefore, the fee paid to close out this capital draw was $1,202.08. The financial outcome is as follows:
Gross Sale of 300 Shares at $260.00/Share $78,000.00
Transaction Fees to Dispose (300.00)
Net Proceeds from Sale $77,700.00
Closure Fee from Margin Account (1,202.08)
Basis in Stock (65,524.33)
Gain on Sale of Norfolk Southern Railroad $10,973.59
Dividends Earned During Holding Period 1,080.00
Total Earnings $12,053.59
Average Cost Basis:
Tranche #1 Purchased on 04/27/2023 (313 Days) $17,324.76
Tranche #2 Purchased on 09/29/2023 (158 Days) 17,530.40
Average Basis of Margin Account Interest Paid 3,237.35
Total Average Basis $38,092.51
Average Annualized Return on Investment 31.64%
Cash Reconciliation:
Net Proceeds $77,700.00
2% Closure Fee (1,202.08)
Loan Payback 60,104.00
Net Cash From the Sale $16,393.92
Gain on Sale of Stock $10,973.59
Interest Paid to Margin Account 5,420.33 *Dollar Amount Recovered at Point of Sale
Net Cash from the Sale $16,393.92
Overall, a decent return on the risk given that the Fund used borrowed capital to make the investment. Using a margin account is a sophisticated tool taught in Phase III of this site’s lessons about value investing. Act on Knowledge.
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]]>The post Buy Norfolk Southern Corporation (Railroad) first appeared on ValueInvestingNow.com.
]]>Today, September 28, 2023, this site’s Value Investment Fund purchased another 200 shares of Norfolk Southern Corporation (Railroad) utilizing its margin account to fund the transaction. The price per share at closing was $197.38. The Fund paid $197.52 per share. Total costs to purchase the 200 shares are as follows:
Market Price/Share @ $197.52 at 3:56PM (200 Shares) $39,504.00
Transaction Fee/Share @ $1.00 each 200.00
Margin Fee @ 2% for Purchase ($39,704.00 X .02) 794.08
Total Capital Outlay (Fund’s Basis) $40,498.08 ($202.49/Share
The historical market price for Norfolk Southern Corporation has only dipped below $170.00 per share once in the last three and three quarter years. This occurred during the pandemic market chaos in March of 2020 (as indicated by red circled zone). The share price peaked at $271 as marked by the red line. Look at this basic presentation chart:
Take note of two key items. First, earnings per share are $11.11 during the last twelve months. In addition, dividends per quarter are $1.35 or currently tracking $5.40 per year for a 2.73% dividend yield. This is really good. One could hold this investment for several years while a value investor waits for the price to return to $250 plus per share to sell the security. Assuming it takes two years to get there, the investment will pay $10.80 in dividends and with a basis of $203.29 (includes the $1 per share transaction fee to sell the stock); total return at $250 sales price per share will equal $57.51 per share on an initial outlay of $202.29. This equates to a little over a 13% annualized return on the investment.
Imagine the return on the investment if this happens within one year? It will be over 26%.
This investment matches all the requirements a value investor seeks:
- A high quality company, a market capitalization of $44 Billion places this company in the top 1,200 U.S. operations;
- Low down side risk associated with the stock’s market price, see the chart above;
- Purchase price is below intrinsic value of $206 per share;
- Market price recapture capacity is high due to the high stable earnings of this company.
In addition, the Fund has sold a PUT Option contract for 200 shares with an expiration date of June 21, 2024. Gross earnings are $1,920.00 (200 shares at $9.60) with a net return after transaction fees of $1,720.00. The strike price is $185.00 per share.
The facilitator of this Fund has written multiple articles about Norfolk Southern Corporation and has made multiple trades as recorded on this website, all of them successful returns on the respective investment. Furthermore, the most recent financial filing with the Securities and Exchange Commission shows Norfolk Southern Corporation earning $576 Million net of reserving $416 Million to address the accident that happened in Ohio. Furthermore, key performance indicators show the company just slightly behind the volume of tonnage at this same point last year. Last year the price per share was $223 per share.
Thus, the low price per share is temporary and once the quarterly report posts in late October, early November for the third quarter, there is a high probability of market price recovery. Act on Knowledge.
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Union Pacific (UP), a Utah corporation is the largest of the six publicly traded Class I Railways operating in North America. Union Pacific is the standard bearer of performance especially since UP has a high price to book ratio in comparison to the other five railroad stocks. From High Price to Book Ratios – Proper Interpretation and Evaluation, the key driver of stock price is stability (consistent performance year after year) of earnings. Shareholders have little tolerance for management if the company under performs. Historically, UP is considered highly stable for the railroad industry.
All of the following analysis, evaluations and opinions that follow stem from Union’s annual report filed with the Security and Exchange Commission. For those of you that want a copy to use as a reference, download it here: UP’s Form 10k for 2020.
This evaluation is divided into four sections:
- Historical Perspective
- Operational Performance
- Financial Results
- Insights
This performance evaluation starts with some historical perspective.
Union Pacific – History of Performance
UP operates in 23 states, Canada and Mexico. UP owns 26,100 miles of track linking the Gulf Coast to the West Coast and has access to another 25,600 miles of track. Furthermore, the company owns and leases 7,600 locomotives and 52,900 freight cars. The company is really a combination of mergers of seven railroads over the years. Union Pacific started out as a chartered company from the Pacific Railway Act of 1862 advocated and signed by Abraham Lincoln.
In 1869, Union Pacific met Central Pacific at Promontory Summit in Utah to complete the transcontinental railroad. In 1880, the mergers begin when Kansas Pacific and Denver Pacific join under Union Pacific to broadly expand the railroad under one umbrella.
Other mergers built Union Pacific over the next 110 years:
- 1901 – Southern Pacific Railroad
- 1982 – Missouri & Western Pacific Railroad
- 1995 – Chicago and Northwestern Acquisition
Today, Union Pacific is the largest publicly traded market capitalization railway in the world. Its revenues are almost one-third of all Class I Railways in North America. What is most impressive about their record is that the railroad has paid dividends for 121 years in a row. It is referred to as the ‘Gran Daddy’ of railroads given its history and industry position.
The company focuses on three groups of commodities as follows:
- Bulk – 33% of the revenue
- Industrial – 36% of the revenue
- Premium – 31% of the revenue
The number one metric to measure a railroad company are revenue ton miles which are the total miles of hauled freight. A secondary measure is dwell time and a tertiary measure of performance is the operating ratio (costs of hauling as a percentage of revenue). Here is a table of the last six years:
Metric 2020 2019 2018 2017 2016 2015
Revenue Ton-Miles (Billions) 385.0 423.4 474.0 466.7 440.1 485.0
Dwell Time (Hours) 22.7 24.8 29.8 30.3 28.1 29.3
Operating Ratio 59.9 60.6 62.7 62.0 63.5 63.1
For comparison purposes, here are four of the other five publicly traded Class I Railways revenue ton-miles (Billions):
Name 2020 2019 2018 2017 2016
Canadian Pacific 151.9 154.4 154.2 142.5 135.9
Norfolk Southern Unavailable 194 207 201 191
CSX 182.6 196 202.9 196.1 Unavailable
Canadian National 230.4 241.9 248.4 237.1 214.4
Union Pacific has 60% more volume than the next closest competitor. The only concerning issue here is the overall drop in revenue ton-miles during the last five years. It would be prudent for an investor to monitor current operational performance indicators (key performance indicators).
Union Pacific – Operational Performance
Interestingly, UP doesn’t report revenue ton miles except annually. During interim accounting periods, UP reports the number of cars moved. In general, there is a high correlation with number of cars moved and revenue ton miles. The correlation ranges from .94 to 1.06. Thus, it is a very reliable key performance indicator for success. Through March 14th, 2020, UP as moved 1,651,399 carloads. They are 8% behind this point in 2019, 1,798,236 carloads. This trend existed prior to the coronavirus market adjustment. It looks like during the early stages of this market, UP’s performance hasn’t been impacted yet.
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]]>Yesterday at 10:45 AM the market price for Norfolk Southern Railway dropped below $199 per share. The Value Investment Fund purchased 100 shares at $199 per share and paid a $1 per share transaction fee. The Fund exercised its margin account to purchase this position. The margin account terms requires a 2% fee and a 1% end of month interest payment on any balance at end of day on the last business day of the month. In total, on April 28th, end of day, basis in Norfolk Southern is 206.04 per share. The following is the basis calculation:
Purchase 100 Shares at $199/Each $19,900.00
Transaction Fee at $1/Share 100.00
Margin Fee at 2% on Total of $20,000 400.00
End of Month Margin Interest at 1% on $20,400 204.00
Total Basis $20,604.00
Basis per Share $206.04
Based on the history of this particular security, the downside risk is low; the upside potential is high. Look at this three year look back:
Act on Knowledge.
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This morning, 09/29/22 at 10:37 AM, the Value Investment Fund sold 200 PUTs on Norfolk Southern Railroad at $6.20 netting $5.20 each after transaction fees. These PUTs have a strike price of $145 each and expire on January 19, 2024.
The Fund uses options, specifically PUTs, to augment the income and boost the overall return of the Fund. The concept is simple. The Fund wants to own certain pre-qualified investments at certain prices; that is, market prices that are well below intrinsic value as calculated for the respective investments. These investments are basically top 2,000 companies trading in the United States, have a good history of performance and are highly stable. Currently, there are 49 researched potential investments spread among 8 different industry pools. Within the Railroads Pool sits a well respected and well managed railway, Norfolk Southern Railroad.
On average, Norfolk Southern has earned more than $6.80 per share over the last 11 years. It pays a dividend of more than $4.80 per year and there is nothing in the financials that would indicate retraction of cash flow or future dividend payouts. Thus, at $4.80 per share, actual ownership equates to a dividend yield in excess of 3.25%. This is simply a rock solid company and the Fund would love to be forced to buy this stock at $145 per share. There is 15 month window of risk here; but the risk is a desired risk, the Fund wants to own this stock at this price. The current intrinsic value exceeds $196 per share. At $145 per share, it is a value investor’s dream situation.
The sale of these PUTs earns the Fund $1,040 with a commitment of $29,200 including transaction fees.
The Value Investment Fund’s current exposure related to PUT options is as follows:
- Union Pacific Railroad – sold in Feb 2020 with a strike price of $155/share and an expiration date of January 21, 2023 $20,129
- JP Morgan Chase – sold in May 2022 with a strike price of $80/share and an expiration date of June 16, 2023 $20,247
- Essex Property Trust, Inc. – sold in May 2022 with a strike price of $260/share and an expiration date of October 21, 2022 $20,880
- Essex Property Trust, Inc. – sold in June with a strike price of $240/share and an expiration date of October 21, 2022 $24,100
- Norfolk Southern Railroad – sold in Sept 2022 with a strike price of $145/share and an expiration date of January 19, 2024 $29,200
*Commitment value includes transaction fees to purchase the respective shares.
Market prices on Sept 29, 2022 are:
- Union Pacific Railroad (Expiration on 01/21/2023) $199.20 (Strike Price of $155.00) Current Deviation = 22.18%
- JP Morgan Chase (Expiration on 06/16/2023) $106.16 (Strike Price of $80.00) Current Deviation = 24.46%
- Essex Property Trust, Inc. (Expiration on 10/21/2022) $244.70 (Strike Price of $260.00/$240.00) Current Deviation = -5.88%/1.9% Respectfully
- Norfolk Southern Railway (Expiration on 01/19/24) $214.55 (Strike Price of $145) Current Deviation = 32.42%
*Deviations > 25% on PUTs are considered favorable and require no reserves.
At this point, only Essex Property Trust, Inc. is a risk of having to act on 10/21/22. The Fund currently has $25,100 of cash available to honor the strike price of $260 per share. It is conceivable that the strike provision batch at $240 per share will also be unfavorable on October 21, 2022. If so, the Fund will sell an existing positive position in one of its existing investments to honor the Option sold. Act on Knowledge.
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]]>The post Union Pacific Loses $20 Billion of Intrinsic Value in 2021 first appeared on ValueInvestingNow.com.
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Union Pacific is considered the granddaddy of railroads. It is the most stable of all Class I Railways and generates over $20 Billion per year in revenue. In 2021, Union Pacific had sales of $21.8 Billion, the 2nd highest ever recorded. Union Pacific generated a pretax profit of $8.5 Billion, the highest in its entire history. In effect, 2021 was one of the best if not the best financial year in the history of Union Pacific. But yet, Union Pacific’s intrinsic value dropped $20 Billion during the same time period. How can this happen?
Value investors focus on intrinsic value and the market’s valuation points. However, the Board of Directors are focused on returning value to the shareholders. Basically, the Board authorized a stock buy-back at a price dramatically higher than the stock’s intrinsic value. The difference is equivalent to transferring intrinsic value to a few lucky shareholders at the expense of remaining shareholders. This business concept of treasury stock (buying back stock) is only effective IF the stock is purchased at or less than the stock’s intrinsic value.
This site’s Railway’s Pool identified in February of 2021 that Union Pacific’s intrinsic value was estimated at $188 per share and that a good margin of safety was necessary in order to earn a good return on the investment. Thus, the buy price was set at $162 per share. The book value on 12/31/2020 was $26 per share. Book value on 12/31/2021 went down to $22 per share; yet, Union Pacific earned $10 per share during 2021.
During 2021, Union Pacific bought back 33,337,620 shares at a price of $7.3 Billion or about $218.97 per share. Union Pacific paid a premium of $31 per share over intrinsic value. Total premium paid equals $1,032,527,000. This is financially the equivalent of wasting $1 Billion of earnings.
The current price to earnings ratio is approximately 25 to 1 (February 2022). Thus, $1 Billion of earnings at a price to earnings ratio of 25:1 is the equivalent of $25 Billion of value. Some of you reading this are sophisticated enough to know that this is the outside market value. Intrinsic value is an internal value, a value that is derived from the power of the company to generate wealth to its owners. For highly stable operations like Union Pacific, intrinsic value is best calculated as function of discounted free cash flow with a very strong terminal value tied to a fair market value of its fixed assets (one of the many different intrinsic value formulas).
Under the discounted free cash flow ($6.1 Billion/Year) method with a terminal value of approximately $80 Billion (see Total Assets on the Balance Sheet with a step-up of approximately 25% for fair market value due to this company’s long life), the total value of Union Pacific is estimated at $98 Billion. With 638.842 Million shares in the market, each share’s intrinsic value is estimated at $153 per share. The facilitator of this site’s Value Investment Club believes a step-up of 25% is extremely conservative and that a more reasonable step-up is around 40% due to the fact that this company’s real value exists only as a going concern. With a 40% step-up, the terminal value increases to $100 Billion and the per share intrinsic value improves to $157 per share. Thus, intrinsic value for Union Pacific is between $153 and $157 per share.
Last year’s intrinsic value was estimated at $188 per share, the difference is estimated at $30 per share; intrinsic value is not an exact science. With 638.842 Million shares in the market, the total intrinsic value decrease is estimated at $19.2 Billion.
A third and more simplistic approach utilizes book value. On 12/31/2020, book value was approximately $26 per share. During 2021, each share earned $10 (see the financial report for Union Pacific for 2021). In addition, each share received a dividend of $4. Thus, book value, without a share repurchase program, would have improved $6 per share to $32 per share. Yet, the actual 12/31/2021 book value is $22 per share. In effect, the Board of Directors transferred $10 of value from existing shareholders to the few shareholders that benefited from the repurchase program. The historical price to book ratio for Union Pacific has been consistently higher than other railroads. Union Pacific’s price to book ranges from 7:1 to over 10:1. Using the more conservative 7:1, a reasonable market price for Union Pacific is approximately $154 per share.
If the book value had improved to $32 per share from $26 per share balance on 12/31/2020, the market price for existing shareholders would also have improved approximately $42 per share. This $42 per share value with 638.842 Million shares outstanding is a total value shift of $26.8 Billion.
Thus, overall intrinsic value has shifted a minimum of $20 Billion in one year. The three different methods above illustrate this intrinsic value loss. A $20 Billion reduction is reasonable and easily justifiable. The reality is straight forward, the Board of Directors of Union Pacific overpaid $1 Billion to repurchase stock in the market. With a simple 20:1 price to earnings ratio, this equates to the $20 Billion intrinsic value shift.
Existing shareholders of Union Pacific now have increased risk exposure for their investment. The increased risk exposure is a direct reflection of the intrinsic value each share holds. One year ago, each share was worth at least $188 per share; now, they are only worth around $155 per share. Granted, this risk exposure will decrease over time due to the fact that earnings per share will improve due to less stock to share future earnings; thus, the earnings per share will improve in the future. However, risk reduction is the number one principle exercised by value investors. Stock repurchase programs are a significant risk to value investors IF the buy back price is greater than intrinsic value. If a buy back program exists for prices less than intrinsic value, intrinsic value improves and risk goes down for value investors. This is one of the sophisticated tools a value investor utilizes when evaluating a security investment.
Union Pacific’s intrinsic value is now reset to $155 per share and the buy point requires a 19% margin of safety; thus, the buy price for value investors is set at $126 per share. Act on Knowledge.
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]]>The post Sold 104.712 PUTs on Norfolk Southern Railroad first appeared on ValueInvestingNow.com.
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Within the railways pool of investments for the Club’s Value Investment Fund, Norfolk Southern Railroad is considered one of the better investments of the six existing railroads in the pool (soon to be five with the merger of Canadian Pacific and Kansas City Southern). It is a highly stable company and rarely performs poorly, either financially or via key performance indicators. Thus, the sale of PUTs on Norfolk Southern Corporation are a safe and relatively low risk options investment.
A PUT is the sale of an insurance policy to an existing holder of stock. The idea is that IF the market price for the stock should suddenly depress to a particular price, ‘Strike Price’, the current holder of the stock can force the seller of the PUT to buy the stock from the current owner of the PUT at that strike price. In effect, the PUT acts as a floor price for the stockholder.
If the reader reviewed the articles on this site concerning Norfolk Southern Railroad, the current intrinsic value of Norfolk Southern Railroad is $204 per share. A reasonably desired margin of safety is 10%. The investment fund was able to sell the PUTs for a strike price of $190 per share. The current market price for Norfolk Southern Railroad on 03/26/2021 is $273 per share. The entire railroad industry is currently at or near the all-time high prices; in effect, the railroad industry is in strong favor with the market.
The table below, specifically the highlighted line for the sale of PUTs tells the story of this transaction.
The fund sold 104.7120 PUTs at $4.20 each. Throughout this entire series of transactions related to value investing, the fund uses an across the board transaction fee of $1 per share no matter the transaction type. Thus, the fund nets $3.20 per share. The investment fund model limits the sale of PUTs at their respective strike prices plus $1 per share to no more than 80% of the fund’s current fair market value. The current fair market value of the fund is $143,646 on Friday the 26th of March, 2021.
This sale of PUTs, if exercised by the owner of the PUTs, obligates the fund to spend exactly $20,000. The risk period is just a tad under 10 months. It is expected that the intrinsic value for Norfolk Southern Railroad will rise to a bit more than $210 per share over the next 10 months. Thus, an opportunity to own Norfolk Southern Railroad at $190 per share is welcomed and desired. Norfolk Southern Railroad is simply an excellent investment and it is highly unlikely that these PUTs sold will be excercised; but if they are, it is welcomed.
Total earnings from the sale of these PUTs are $335.07 after fees. This amount is added to the cash account of the Value Investment Fund. Act on Knowledge.
Value Investing Episode 1 – Introduction and Membership Program
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If a railroad is bent, the train shall turn over; if a man’s character is bent, he shall turn over just like that train. –
Mehmet Murat ildan
Dividends and earnings analysis is one of the core requirements of calculating intrinsic value via security analysis. There is a relationship between dividends and earnings; one is a function of the balance sheet, the other is tied directly to the financial performance of the company as reported on the income statement. In general, there must be earnings in order to pay dividends. Investors, especially those holding common stock want rewards for their investment and often, are short-sighted when it comes to receiving dividends. Earnings reflect the power of the company to generate value for the investor. With value investing, the key tenet is to buy a security at as low of a price as allowed by the market and then sell this security at the highest price. In the interim, dividends serve as compensation for a value investor’s patience while waiting on the market price for the security to recover to a reasonable high price.
Railroad stocks are unique. This is one of the few industries whereby all the players have a very similar revenue and cost of production business matrix. There are exactly six publicly traded Class I Railways in North America. All of them have to play by the exact same set of legal compliance requirements; utilize the same physical and technological systems; and cooperate with each other to transport goods across the continent. Interestingly, all six have similar financial characteristics:
- All generate a profit, the lowest net profit within the group is 22.8%;
- All have positive operational cash flow and good free cash flow;
- All issue dividends to their shareholders;
- All have gross profit margins > 34.5% with the average over 37%;
- All have low administrative overhead generating high operational profit margins; AND
- All have similar 10 year growth lines related to share price.
One of the metrics that separates them from one another is their dividends and earnings relationship. Performing a dividends and earnings analysis gives a slight advantage to the value investor over traditional traders and in some cases, if the analysis is done properly and timely, a distinct advantage over professional traders. This particular article is in-depth and educates the investor about this aspect of security analysis for this one industry. The opening section introduces the relationship of dividends and earnings with business in general. There are certain key principles that bind these two financial items together. Understanding this interrelation is key to application of determining value for a company. With this understanding, the second section below develops the railways industry as a whole. It looks back over the last ten years of actual dividends and earnings for all six railroads and analyzes their trends. Here, the impact of this relationship and how it affects the stock market price for the industry as a whole is evaluated.
The final section explores each company individually and explains how this dividend and earnings analysis impacts each company’s respective intrinsic value. The goal is to assist with determining reasonable relationships to the actual stock market price for the company’s shares. The end result is security analysis for each railroad stock as it relates to the dividends and earnings.
Understanding the relationship of dividends and earnings is essential as one of the value investment metrics used by value investors when determining intrinsic value along with expected market highs and lows for a particular stock.
Dividends and Earnings Analysis – Financial Relationship
Purpose of Earnings
If you read Johnson & Johnson’s credo, it clearly identifies three distinct goals of the company. First, it states that the patients, doctors and nurses are the company’s primary responsibility. Secondly, the credo speaks to employee security. Finally, the credo states that it is the goal of the company to make a profit; but it goes further:
Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed, investments made for the future and mistakes paid for. New equipment must be purchased, new facilities provided and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.
Notice how Johnson & Johnson’s credo explains how the profits are to be used. There must be investments made for the future and to pay for mistakes. Furthermore, tangible fixed assets must be acquired to fulfill the need to innovate and conduct research.
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“We want to hear the iron horse puffing through this valley.” – Brigham Young 1867
Union Pacific is a high quality stock. Over the last twenty years, this company has never failed to earn a profit. During this time period, there have been two recessions. The simple fact is that Union Pacific is a solid investment. The company has paid a dividend for the last thirty years. Its current yield at $210 per share is 1.83%.
Union Pacific’s intrinsic value is estimated at $185 per share. Thus, any opportunity to own Union Pacific for less than $185 per share is considered an excellent buy.
From the Lessons Learned article for the Value Investment Fund’s 2020 performance, one of the additional tools to leverage higher the Fund’s annual return is to sell PUTs. A PUT is an option for the holder of the PUT to sell an asset, in this case stock, for a preset price referred to as ‘Strike Price’. The seller of the PUT is basically selling an insurance policy that if the market price drops to the strike price, the seller of the PUT is willing to buy the stock at that price. PUTs are a viable alternative to owning stock at less than intrinsic value.
The Club’s Investment Fund desires to own Union Pacific. Why? Union Pacific is considered the best performer of all publicly traded Class I Railways (six companies). Railroad companies:
- All generate a profit, the lowest net profit within the group is 22.8%;
- All have positive operational cash flow and good free cash flow;
- All issue dividends to their shareholders;
- All have gross profit margins > 34.5% with the average over 37%;
- All have low administrative overhead generating high operational profit margins; AND
- All have similar 10 year growth lines related to share price.
Any chance to purchase a high quality stock at a good price is almost considered stealing. Selling PUTS provides this opportunity to basically purchase a good company at a low price and then simply wait for market recovery and sell high.
The Fund sets up these opportunities by selling PUT options. In this case, on Thursday the 18th of February 2021, the Railways Pool of the Fund sold two sets of PUTS. The first are short-term PUTs with an expiration date of June 18, 2021 (four months) with a strike price of $170 per share. Basically, the Fund wants to buy Union Pacific for $170 per share if the opportunity arises during the next four months. Here is the options report from the 18th of February, 2021.
The last sell price is used, $3.05 per share. The Fund is interested in owning $20,000 worth of stock at $170 per share and a trading fee of $1 per share. Thus, total cost per share is $171; which means the Fund sold 116.959 shares and netted $2.05 per share (remember, each transaction costs $1 per share). From this short-term option, the Fund nets $239.77.
What the Fund really desires is a greater safety margin, i.e. purchasing stock for a price that is at least 20% less than intrinsic value. Since intrinsic value is estimated at $185 per share, any opportunity to purchase Union Pacific for less than $148 per share is considered a steal.
The Fund researched further and discovered a second set of PUTs called long-PUTs. Here, PUTs are sold for a much higher price per share but have extensive holding or policy periods. For a long-PUT dated January 20, 2023 (23 months out), with a strike price of $155 per share, the current price is $14.80 (most recent bid submitted). The net is $13.80 per share sold.
To own $20,000 of stock at $156.00/share (includes $1 transaction fee per share), the Fund sold 128.2051 PUTs and earned $1,769.23 after a transaction fee of $1 per share.
Many of you reading this are wondering, a good safety margin is to own the stock with at least a 20% safety margin, i.e. 80% of $185 estimated intrinsic value per share. Notice that with this sale of a PUT, the Fund earned $13.80 per share. Thus, if forced to purchase the stock, the effective true strike price is $141.20 (face strike price of $155 less $13.80 earned upfront per share). The effective margin of safety is 23.6%.
The real benefit of this is that in the interim, the Fund can put this $1,769.23 to work and earn a return by investing the net proceeds.
A common inquiry from students is why not sell long-PUTs on all potential investments. It is an excellent way to earn a good return with minimal risk. One of the four principles of value investing is to own high quality financial instruments at very good prices. Ownership of a security at dramatically less than intrinsic value is the best risk reduction tool for value investors. The answer is that, if the market declines for any high quality stock, it is most likely across the board for all members of the investment pool and the other pools. Deep market price drops are driven by economic wide fluctuations and rarely if ever does a single company in the portfolio drop in price on its own. Thus, if the Fund sold long-PUTs on all its potential investments and there is a deep market price drop, the Fund would be unable to cover the costs associated with the purchase of all positions in PUTs. The absolute maximum face value of PUTs cannot exceed the current basis in the Fund. In this case, the Fund’s current basis is $100,000.
Thus, the sale of long-PUTs should only be done with the best quality stock within each investment pool. Only sell PUTs that can be covered. This business principle is covered in more detail in Phase Three of the value investment membership program.
All total, the sale of PUTs on Union Pacific earned the Fund $2,009 and this was added to the cash account at week’s end 02/19/2021. As a side note: The Fund owned Union Pacific PUTs that expired on February 19, 2021. Thus, the Fund currently is only obligated to pay out $80,000 if all PUTs are exercised. Act on Knowledge.
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]]>In keeping with the value investment fund’s pattern, on Friday the 29th of January, 2021 the Fund sold 113.6363 PUTS on Union Pacific Railroad. These PUTS have a strike price of $175 and are currently sold at $6.24 each. The Fund netted $5.24 each after a $1 per PUT fee. Total realized value equals $595.45 (113.6363 * $5.24). See the table below.
Until the end of the day on May 21st, 2021, the railways pool of the Value Investment Fund is obligated to buy Union Pacific Railroad if the market price dips to $175.00 per share. The pool’s current intrinsic value calculation places Union Pacific Railroad’s buy price at $180 per share. In effect, the Fund would welcome an opportunity to purchase the stock at $175 per share. If forced to buy, the Fund would invest $20,000 which is the buy price of $175 plus $1 per share transaction fee. Take note, the action uses the last known selling price of $6.24 and not the ‘Ask’ nor the most recent ‘Bid’.
PUTs are a form of issuing insurance to a current holder of stock. That holder purchases the PUT ensuring a floor price for their respective shares. If the share price should ever drop to the PUT’s strike price, the holder of the PUT can force the seller of the PUT to purchase that share at that strike price; effectively limiting their loss just like insurance limits someone’s loss in an accident. When used smartly with value investing, value investors can take advantage of this simple option to leverage up their annual returns for their respective investment fund.
Union Pacific Railroad’s current market price is near $200 per share and peaked on January 8, 2021 to $221.28 per share. Thus, owning such a high quality company at $175 per share is desirable. During 2020, this Fund bought and sold Union Pacific twice. In February of 2020, the Fund bought Union Pacific for $157 and sold in June for $183 netting a good return in a short period of time. In October the Fund bought Union Pacific for $174 each and sold the first week of January 2021 for $215 per share; again earning a good return on the investment.
Historically, Union Pacific rarely has the necessary deep drops in market price and then market recovery in a short period of time (less than six months). It is simply one of the best stocks out there to own. The company has very stable earnings, an excellent record of good operations and is considered the best run railway of the six Class I publicly traded railways. If the market price were to dip to $175 per share, market recovery to $215 per share would most likely occur within six months. But even at one year, the return on the investment would equal 21.6%.
This follows the Fund’s tenant of buy low and sell high. In addition, it complies with the four primary principles of value investing:
- Reduce risk by only buying high quality top 2,000 companies that have stable earnings and are well managed;
- Buy at or below intrinsic value which for Union Pacific is $180 per share in 2021;
- Sell at or near a reasonable market recovery price;
- Maintain patience, the historical pattern and of course the underlying attributes of Union Pacific are there for this to materialize. Act on Knowledge.
Value Investing Episode 1 – Introduction and Membership Program
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