The Curious Investor

With the Fed’s opening of an emergency credit line for companies facing insolvency due to the current credit crisis, markets have rebounded swiftly and we’re looking at 2% days across the major indexes. I should be jumping for joy given that we haven’t seen such green days for a while now. Unfortunately, both of my portfolios are down big today despite the rally. Why? I happen to be invested in two health insurers, the one industry, which is not responding to the Fed action today because there was bigger news last night. WellPoint, a major insurance provider, warned on its profit forecast and cut its 2008 forecast to $5.76 - $6.01 per share from an original $6.41 per share. This represents a 6-10% decrease in projected earnings and represents an expectation to grow 3 - 8% next year as opposed to an original estimation of 15% earnings growth. Such a major revision had ramifications for all health insurers. What does this mean for my positions in Humana and Aetna? Well, it’s bad news for me, but hopefully a valuable lesson for readers of this blog.

An Investors’ Perspective (Aetna)
Given the current market climate, I’ve found myself often repeating Ben Graham’s mantra, “In the long run, the market is a weighing machine. In the short run, it is a voting machine.” What this basically means is that a person who invests with conviction and with fundamental principles should not worry about near term and, often unavoidable, event risk. Instead, you should hold your investments with confidence that as future events unfold, short term shocks will be smoothed out and overcome.

No one likes to lose money from day to day, but with my investment in Aetna and my strategy for Portfolio B as a whole, it is important to keep an eye towards my underlying reasons for investing in Aetna. My investment thesis goes as follows:

• Industry leading ability to manage costs and provide innovative products
• Positioned to benefit from increasing political support for mandated healthcare
• An industry which should maintain demand even in an economic slowdown
• Positioned unlike any other large firm in the health insurance industry to grow revenues through expanding enrollment

These basic operational and strategic points were supported by the fact that the company seems to have embarked on an effort to expand enrollment and has subsequently submitted six straight quarters of impressive year over year growth and continues to project 15% growth throughout the next year. Generally speaking, I expect P/E in the range of 10-12 for a company with minimal growth, yet this firm is set to grow earnings well in excess of 10% and thus I had an expectation for the stock to reach a value north of $60.

As Aetna has reaffirmed its profit outlook (albeit with little mitigating affect on today’s drop in share price), I do believe that my fundamental reasons for investing in this company remain in tact and I should be willing to continue to hold despite my current paper loss. In fact, if I had more money to commit, it may even be prudent to begin allocating into this position so as to cost average down my buy price and hopefully profit more as the company’s performance and improving market conditions bring the stock back to my fair valuation level.

Truth be told, the stock did reach “fair” valuation for a brief moment about a month ago and I likely should have considered a sale then, unfortunately, subsequent market volatility beat it down faster and with more vigor than I would have anticipated. Here, is where I made the mistake of investing in a stock without a significantly high margin of safety. My fair valuation for the stock translated to about a 20-25% gain on my buy price. This left little margin in the case of near term event risk and, as a result, I’ve paid the price. I do, however, intend to continue to hold this stock provided new information surfaces which changes my intrinsic understanding of the company and its operational strategy.

A Trader’s Point of View (HUM)
Humana was a company that I picked based on my proposed earnings beat strategy. The company’s stock looked to be coming out of a longterm base (nearly 1 year long) and had been on an even longer uptrend (a continuum of higher lowers and higher highs lasting 5 years). Earnings performance had recently improved significantly with quarterly reports showing upwards of 30% year-over-year growth with little response in the stock’s price. I projected the stock’s basing to be completed and primed for a breakout right around the same time as its Q3 2007 report and I positioned myself to buy. Things worked swimmingly with a pop on earnings, but subsequent doldrums due to political pressure. (Humana, it turns out, is unique in that it makes most of its money off of providing Medicare coverage and politicians were unhappy that it could be so profitable doing so.)

Despite this, technicals remained strong, and I held the stock expecting a continued run now that it’s earnings performance had been “discovered.” Q4 earnings were strong once again and the stock roared to near $90/share. It was hear that my weak sell strategy cost me. Early in my investing experience, I lost out on significant earnings with some stock picks (notably GRMN and TIF) and I decided this year to focus on trying to find exhaustion sell points. That is, chart and indicator patterns which signify a rally is over. Typically speaking, this involves waiting for a data point of a high followed by a lower high.

Again, inexperience seems to have cost me, as this strategy necessitates a stock to bounce after an initial shock knocks it off a rally. Here again, in this volatile and uncertain market, buying power was not around to produce a typical bounce for Humana. The stock swiftly fell back to break out level where I thought that it had found buying support. Clearly, after today’s action, the support is gone. Humana’s stock has fallen out of its breakout price level and below that of critical support at its previous base level. This indicates to me that the supply and demand equation for this stock has all but evaporated. I have no intentions on continuing to hold this stock and will likely look for an opportune time to unload my position after today’s initial sell-off.

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