BlastInvest
Blast Investor Real-time Plus           by Henry Lu

Portfolio Review - Value Investing Themes and Outlook

12/31/2005

BIRTP 2005 Performance verses Goal

2005 is tough year for making money in stock market. Nasdaq index is only up 1.37% in 2005 and the S&P 500 index is only up 3.00%  for the year. The Blast Investor Real-time Plus (BIRTP) model portfolio continues to beat the index handsomely with gain of  30.42%. Since inception for past 2 years,  BIRTP model portfolio is up 108.1%, significantly outperforming the S&P500's 12.0% return.

Our goal is to help BIRTP subscribers to make above average return using value investing strategy. Specifically our investment return goal is to deliver 20% per year average return for BIRTP model portfolio. So far, we are satisfied with our result. Not only BIRTP performance beats our internal 20% average yearly return goal significantly over past 2 years, BIRTP also beats 20% one year return in 2005. We also believe that our newsletter's investment return would beat most of our peers in investment newsletter industry or in mutual fund industry. Why did that happen?

BIRTP Porfolio: Focused Investing, Hedge Fund Style Investing

The first reason is the operation style of BIRTP model portfolio.

We require that each stock pick would either have low price to true net asset value, or low price to true owner's earning to meet our goal of potential 20% investment return. We picked our stock picks mainly with bottom up approach with focused portfolio of 10 stocks. This focused value investing style would allow us to set very high stock picking criteria and deliver high returns. In other words, our value stock picking criteria is so high that most of stock picks that many value mutual fund managers love would not meet our criteria.  We probably can not deliver high returns with 30 or 40 stocks, we can not find that much stock picks with our criteria. But we only need around 10 stocks and 10 stocks would provide us adequate diversification protection already in our belief.

Mutual funds typically have all kinds of rules and restrictions. Their fund size is so big and they may not be able to invest into small cap stocks. They may not be able to invest into troubled stocks or delisted stocks because of their rule.  BIRTP has no such restriction or rule. BIRTP runs like a value strategy hedge fund that can invest into small cap stocks, large cap stocks, troubled stocks or delisted stocks freely. The only rule BIRTP has is to abide by value investing method, nothing more.

2 Investing Themes

2 themes affected many of our decisions and helped our investment return in 2005.

The first theme was our belief of relatively not exciting or even slightly bearish outlook of stock market going forward in the next decade. At end of 2003 and beginning of 2004, we started to believe that the stock market was not going to be bull market as many fund managers were believing and are believing. Our bearish thinking continued through  2005. This belief only grew stronger after we studied stock market cycles and commodity cycles in 1970's and before.  In a long dragging flat to bear market environment, the stock market would gradually be tired of any bullish talking. The average valuation or PE multiple of the stock market would gradually compress to its historical mean valuation. In extreme case of bear market, the average valuation or PE multiple of stock market may compress to historical bottom at average PE of 10 even if the stocks are high quality well known big cap stocks.  Most of Wall Street analysts or fund managers are pretty young and they only lived through multiple expansion period of bull market between 1980 to 2000.  When Warren Buffett started his investing career in 1950's to 1970's, there were periods of time that even Coke Cola would only sell at PE around 10, half of current PE. We actually studied many stock picks that Warren Buffett invested in 1970's and found that he indeed invested into many of them when they were sold at PE around 5. This could happen in next decade.

Our investing strategy based on 1st theme was to avoid relatively high PE growth stocks and to focus only on deep value stocks. BIRTP exited all our growth stock positions on NTES and SOHU in 2005 and never re-invested the proceeds into other growth oriented stocks. Although we continue to believe that Buffett type growth stocks with high return on asset, with consumer monopoly power would continue to offer attractive long term investment return,  we had not found any such type of growth stocks at attractive valuation to meet our 20% return goal. We simply did not want to pay high price for high quality stocks and we did not want to pay high price for growth because of our belief in this first theme. We would rather wait or look elsewhere for deep value stocks. Deep value stocks are not hostage to this "PE multiple compression" phenomena because multiples of deep value stocks are already below historical mean or even historical bottom. The PE of deep value stocks we were looking for typically would trade at true owner's PE significantly below 10 or at price to true net asset value at big discount. This theme played out very well and BIRTP was able to generate big returns in deep value stocks such as NRG, USG, ADGO, EXX.A and GKIS while many of our peers suffered from this "multiple compression phenomena" .

The second theme was our belief that high energy price would continue for long time, possibly for next decade.  We aggressively invested into and held on cyclical energy stocks such as CHK WLL and NRG.  These stocks not only had high return on capital, they also offered cheap price at big discount to their net asset values.

Wall Street did not like energy stocks because average energy price of past 20 years was very low and past 20 years of energy business was horrible with lots of bankruptcy filings. Stock market and Wall Street only has short memory and they forget about period before 1980. This memory of past 20 years of horrible business is deep rooted in their investment analysis and thinking. In a typical oil stock investment report, wall street analysts or fund managers would use average oil price of past 20 years or use US government energy outlook as their valuation basis of any oil or energy stock. The dominant belief in Wall Street is that energy price would drop to its historical mean so that high energy price is not sustainable. What Wall Street missed is that average price of past 20 years of energy price was not historical mean price, it was only average price in the bear market. Commodity market is cyclical with very long cycle time frame. If we go back to history of oil commodity price or coal commodity price, the bull market typically lasted for 15 to 20 years and the bear market also lasted for 20 years. There was economical, political, business reasons for such long cycle to exist in the past.  The similar reasons for the past long term cycle of energy commodity market still exist today and I expect this time the bull market in energy commodity is not too much different from past.  It is pretty dangerous to assume that "this time is different". This time is not different in energy or commodity market. The bull market in energy commody will stay for years just as they did more than 20 years ago.

In the end, the second theme played out very well in 2005 for BIRTP while many of our peers in investment newsletter or mutual fund world missed huge energy stock rally in 2005. In last month of 2005, even US government admitted their low-balling mistake on energy price projection and issued a much more bullish outlook on oil price for next 2 decades.

Looking back for past year, BIRTP had big losses in individual stocks such as OCAI and SOHU. However, the successful results from above 2 themes overwelmed the losses in OCAI and SOHU so that BIRTP still generated huge return overall.

2006 Outlook

We believe the 2 themes will continue in 2006 and for quite while. These are long term economical and business trends that will not change in short time frame. We will continue to ignore most of high quality stocks or growth stocks because of their high valuation. We will continue to hold our current deep value stocks and energy stocks or to look for better replacement in these 2 themes.

Although we are not very excited about stock market overall going forward, we do not see big bear market coming. Although we believe US economy will not be good enough to support a bull market, we believe the current economy is healthy enough to support flat or zigzag market.

Although BIRTP model portfolio has generated huge average return over past 2 years, we do not believe this is sustainable investment return in the long run due to various risks and our stock picking limitations.  Past performance is not indication of future performance. Further more, even if our investing themes are correct, value investing method only works in the long term, and it may not work in weeks, months or years. Therefore, it is very possible that BIRTP model portfolio would under-perform in the future for quite while.

Having said that,  we are optimistic in the long run and we have strong confidence in the investment method championed by Benjamin Graham and Warren Buffett. This method has worked in past decades and we strongly believe that it will work in the future. As author of BIRTP newsletter, I will continue to invest my personal money into every stock picks of BIRTP model portfolio as disclosed before.




Blast Investor Model Portfolio Update

(as of 12/31/2005)

Model Portfolio - Performance

BIRTP
 S&P 500
Portfolio inception date
 12/31/2003
 12/31/2003
Portfolio inception value
 $89,000
 1114.10
Portfolio 12/31/04 value
 $141,981.00
 1211.92
2004 Performance 59.53% 8.78%
2005 Performance
 30.42%
 3.00%
Total Performance (Since Inception)
 108.1%
 12.0%
Average Yearly Performance (Since Inception)
 44.2%
 5.9%