CANROYs Remain Attractive as Oil-Related Investments

by: Jack Yetiv August 14, 2008 | about stocks: HTE / PVX / PWE    

Jack Yetiv

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Jim Kingsdale wrote an article on Seeking Alpha yesterday entitled "A Case For Retreating From Oil Investments." I wrote the following piece in the Comments section, but have decided to submit it as a complete article as well. I have been bullish on oil and gas for more than a year, beginning well before oil crossed $100, and I remain so today. Although I have been bullish on oil, I never called for oil to hit $150 this year, or, perish the thought, $200.

In an article I published here in early 2008, I said I expected oil to cross $100, cross $110 and test $120, but then spend most of this year between $100 and $120. That remains my prediction. In my predictions, I did miss the irrational rise to almost $150, and perhaps I will be wrong again and oil will go below $100 and stay there for a while.

But I doubt it.

As Mr. Kingsdale has correctly stated, all the bearish factors he discussed in his article could have been perceived 45 days ago. Indeed, they could have been perceived 145 days ago. So that is not the reason for Mr. Kingsdale's change of heart about the suitability of oil as an investment. Instead, his change of heart is due to his "listening to the market."

But, at most, the market today is telling us that oil was overpriced at $147. It is not telling us that oil is overpriced at $115. Yes, I know that some of the technicians in the crowd believe that oil's recent swoon indicates it's going to $60. But those technicians didn't tell us it was going to go to $147 less than two months ago, so we can all admit that technical analysis of where oil is going to be next week or next month is almost useless.

What does help is a supply-demand analysis, which the author has done, but I think he has missed some very key factors, which I discuss below. First, and perhaps of greatest importance, Mr. Kingsdale dismisses the thought that Saudi Arabia [SA] will reduce oil production because it is "committed" to producing more. I'm not sure what "committed" means, but I know that one phone call from the King could reduce Saudi oil production by 1 million barrels per day [mpd]. I wouldn't be surprised to learn at some future time that some of the 500,000 bpd in increased production that SA ramped up in May and July of this year has already been reversed, and if oil breaches $100 (which it might well do in the next month or two), expect OPEC (not just SA) to announce a reduction of up to 1 mbd at their next meeting.

The King and the Saudi oil minister have said on several occasions that Saudi oil should be saved for future generations. $80 oil would provide a powerful incentive to do exactly that--especially since SA knows that if they wait just 2-3 years, the world oil situation will be much tighter and they will be able to get much more for their oil.

The other factor not taken into account by the author is that a significant portion of marginal oil production today is simply not economical at $70 to $80. Will the Brazilian Tupi and Carioca fields be produced if PBR believes all it can get for that oil is $80? I highly doubt it.

Will the Arctic be drilled (assuming it's allowed) for $80 oil? Again, I doubt it. I realize these are longer-term projects that won't produce in the next 2-3 years, but even today, there are a lot of marginal fields being pumped for $120 oil that will be shut down if only $80 can be gotten for that oil. Many enhanced oil recovery and tertiary techniques, and even oil sands production, are not very profitable at an $80 price point.

Finally, it has often been said that "the cure for high prices is high prices," but the same works in reverse--"the cure for low prices is low prices." If oil goes back to $80, and gas back to $2.50, demand reduction will be muted, if not entirely reversed. This, combined with lower production, will act as a self-correction mechanism to low oil prices.

In summary, I believe that oil will continue to trade between $100 and $120 this year, and that certain oil-related investments are worth holding. Of course, if Israel attacks Iran or the Middle East destabilizes in some other way, oil could well test $150 this year.

In the past year, I have played oil very simply--by buying and holding shares of three Canadian royalty trusts--HTE last year, and PWE and PVX this year. Despite the gyrations in the oil market--and even in the value of these stocks, I am about at break-even with them. But in the past year--which has not been kind to the markets--I have collected about 15% in dividends. Thus, my total return of 15% is not bad given what has happened in the markets in the last 12 months.

And these generous dividends will continue to be paid unless oil goes under $80 and gas under about $7.50, the likelihood of which I believe is very low (well under 10%). Of course, if these stocks drop another 10% (which they might if oil goes to $100), I will buy additional shares which will then yield nearly 17%.

To me, these stocks offer a wonderful dividend, which also protects against any major drops in the stock price, while offering substantial upside over the next few years.

Disclosure: I hold a large long position in both PVX and PWE.

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This article has 93 comments:

  •  
    Aug 14 08:15 AM
    Jack, great article as usual. I would be interested in your comments on General Motors Bond issue (symbol GMS). Currently paying a 16% dividend/interest. I am using it as a hedge against lower oil prices. PWE goes down, GMS goes up. Collect the dividend in the meantime.
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  •  
    Aug 14 08:45 AM
    I own pvx and hte both pay generous divi/what will happen after 2011 with canadian tax system god knows. great article
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  •  
    Aug 14 09:13 AM
    I also have these three stocks, and have been adding to them as the price goes down. They provided a terrific cushion when my financial stocks went haywire, allowing me to do better than break even. I understand that the Canroys are all making provisions for 2011, and don't expect things (for investors) to change much, but I figure another couple years will be okay anyway.
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  •  
    Aug 14 09:15 AM
    What does the OP think will happen to the Canroys after 2011? Convert to MLPs? Become a US corporation?

    What will happen to unit price and yield?
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  •  
    Aug 14 09:30 AM
    Jack,

    Thanks for the article. I'm curious to know if you, or anyone here for that matter, takes advantage of the generous canroy DRIP programs? Many of them offer up to a 5% discount on reinvested shares. I own a small amount of PVX in my ameritrade account but they don't reinvest the dividends for me. I need to follow my own advice.
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  •  
    Aug 14 09:43 AM
    You are relatively new to the game. I have been in the CanRoys since PetroFund traded on the Amex on a pre-reverse split basis of $15 or about 5 years ago. PVX, when it was around $8, I was in PGH at $16 and left around $24, will get back in soon. Remember PWI, I got in around $19 and rode it to $30 before getting out at about $22 just prior to their take over for cash around $25-26. Used it to get into Canetic etc.

    I've gone through dozens of Quarterly and annual statements and have yet to find another company as mismanaged as PWE.

    Last month you had PWE going to $48. This month you have yet to provide an explanation of the horrendous quarterly they provided.

    You made a statement that HTE had a payout above 100% of their cash flow when in reality it was due to the inclusion of non-cash items. Do you actually bother to go through the hedges of each company going into the future or do you just look at cash flow as a whole?

    When you make a call, at least have the integrity to face the music rather than go on as if you were right all along. Have some professional pride.

    I am not a professional nor do I profess to be one at least currently but I have been an investor for 35 years, have taken my lumps, been to Emergency rooms twice because of Anxiety Attacks because of faulty calls made by myself to members of my family and friends. I still make bad calls but at least I admit to doing so.

    What PWE did occurred prior to the drop in Oil. The writing was on the wall when they incurred debt which settled the day before the Dividend was to be paid.

    What price did you buy them and what is the price now is the question not what you have received in dividends. Because when push comes to shove, if you have to sell for whatever reason, this will be a gain or a loss.



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  •  
    Aug 14 10:38 AM
    A nice analysis of the risk factor in production.... Lower oil prices mean MORE consumption and LESS production, thus leading to higher oil prices.

    The Canroys, along with any energy producer, will be volatile and continue to be so. If you want safe income, buy US bonds. If you want risk and more income, Canroys are there.
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  •  
    Aug 14 10:42 AM
    Thanks for the comments. As to GM bonds, I am not familiar with the specific issue, but I am worried about the whole US auto industry, so personally, I would avoid. Not an informed opinion--but my 2 cents' worth.

    Tax changes in 2011--whatever their impact will be--are already priced into the Canroys, and investors' perception of same partially account for these companies' terrific yield. Several things to keep in mind. First, most of these companies have "tax pools" that will keep them tax free beyond 2011--up to 2014 in PWE's case, as I recall.

    Second, if oil in 2011 is still well over $100--as many people expect it to be--PWE will still be paying about 15% on its current price, even if it converts to a taxable corp or an MLP.

    Third, many people expect that oil might well go to $150 or more by 2011. Although I cannot intelligently guess what oil will do in 3 years, if oil does that, expect PWE, PVX and their brethren to be paying a yield in excess of 20-25% on today's purchase price. Since that yield is unrealistic, the stock price will increase by 50% to bring the yield down to 13 or 14%.

    Finally, there may be a strange effect when 2011 rolls around and investors realize that the Canroys are doing fine. Yields might actually DROP to a more reasonable 10%--which means the stock prices will climb. This would happen when investors realize that dividends will continue to be paid and that the Canroy businesses can operate just fine in a taxed environment. This would be especially true, of course, if commodity prices are high in 2011, as many (including Mr. Kingsdale) expect.

    Therefore, 2011 (or 2014) changes do not concern me very much.

    Further comments below.

    Jack
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  •  
    Aug 14 10:56 AM
    As to the DRIP, no, I have not taken advantage of it because I like to time my purchases, and because it's a bit more complicated to do when a broker holds your shares.

    Finally, Mr. Paultaut. He always bashes me and my Canroy recommendations--while telling us how he has made money buying Canroys. In his latest rambling comments (ie, what do his panic attacks have to do with investing?), he criticizes me for not admitting that I was "wrong." He is referring to articles I wrote several months ago expecting that PWE may well hit $40-50 by the end of the year.

    First, the end of the year isn't here yet, so I am not "wrong" just yet. Having said that, although it is not impossible, I now no longer expect PWE to hit $50 by the end of this year after having observed what happened to the Canroys as oil ran to $150 and nat gas over $13. In a word, "not much." Sure, PWE ran to $35, but that is trivial in the face of oil and gas prices that would have more than tripled PWE's free cash flow (cash flow left after paying dividends and capex).

    I think $40 is within reach by the end of the year if oil remains where it is today and nat gas strengthens closer to $10, which could well happen with one hurricane or if the summer turns hot again. If neither of those happen, I think PWE will remain in the upper 20's and low 30's.

    Further comments later on.

    Jack
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  •  
    Aug 14 11:07 AM
    Jack--what exactly happens from a tax and payout perspective to PVX and PWE after 2010, the last year the Canadia government allows the CRT's to function as they have been? Thanks
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  •  
    Aug 14 11:32 AM
    Paultaut: You sound like a very experienced investor in the oil patch. I too have been an investor for about 30 years. During that time I have had long positions in Exxon (before and after merging with Mobil), Shiningbank, HOGC, OKE, BRE, & PWI. I sold OKE at a profit and bought OKS with the proceeds. I sold BRE at a profit (a little early as it turned out). I sold PWI after they took over my Shinngbank position, again at a nice prodit. I currently hold long positions in ATPG, BPT, BQI, BQI-WT, FRO, HTE, KMP, KOG, LINE, OKS, PAA, PBT, & XOM.
    Some of these positions I have been in for several years, others for only a few months. I agree with most of your post - PWE is a dog. However, I do believe that generated income, both from dividends and from selling covered calls, is every bit as important as share price. I have had my position in FRO for about 18 months and have received over 30% in income during that time, providing a big cushion against any drop in share price that may have occured during that time (altho share price is up too). I intend to keep this position and milk it for all it's worth until I'm exercised out (at a profit) with a covered call. My experience with PBT has been similar. Finally, altho I am willing to put my money on the line based on my research and experience, I would never give investing advise to my family or friends. That way I stay out of the ER due to anxiety attacks.
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  •  
    Aug 14 12:50 PM
    Own HTE, PVX, AAV, PVX, PGH-- and the Brompton Equal Weight O&G fund, OGF-UN.TO. OGF holds about 5% of these plus Baytex and Enerplus etc. and is managed by Manulife with expenses recently reduced. Pays .07mo /.84 yr now so yield about 11% or so. Ernie M, you could use this for a more conservative approach to the Canroys.

    These are proven resources with new wells coming online all the time, plus each has different mix- AAV more gas, HTE the refiner on the East Coast close to Europe--a strategic holding for refined products for Gr. Br/etc. with Russia being so aggressive. Then you have PVX which sold US properties for a lot of cash and paying down debt/growing. Agree PWE seems to be getting too big for it's britches and could be better mananged. Probably more consolidation coming which puts a floor under current prices. A lot of time before the tax laws change, a lot can happen so not a concern. Exxon could buy a bunch of these now for peanuts using it's cash via its Imperial Oil subsid. Falling Mexican production a plus too, here are the Canroys close and increasing production, thus transportation savings over Mideast/African Oil. The plusses just keep adding up. Keep averaging in more and reinvesting your divs if you can, especially when the market is down and panicking! The dollar is still way down and Prime West (PWI) takeover at $26 by Dubai is a "prime" example of how much potential is in these companies in a "safe" country.
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  •  
    Aug 14 12:59 PM
    On your comment with respect to oil sands, I disagree. Oil sands, especially the mining operations, are already profitable at $40 oil, including capotal costs. So there is no doubt that they would continue to produce at $80 oil.
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  •  
    Aug 14 01:26 PM
    I am also not pleased with the management of PWE. I agree with what the other commentators said about PWE. I my opinion, PWE took on too much debt and has higher expenses than they should. If lots of new natural gas is found in the US and makes it into the market, NG could drop to $7.00 or $6.50 and at these prices, PWE may suffer lower cash flow and negative EPS as well. I sold my PWE at $35.00 when all the Canroys were near their 52 week highs.

    Disclosure - I do not own any oil or NG related stocks nor am I short. I might buy some when they are cheaper.
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  •  
    Aug 14 02:02 PM
    Jack, I thoroughly enjoyed your post. I'm also an avid reader of Jim Kingsdale. I would be very interested in your views about COS and BQI
    Reply | Link to Comment
  •  
    Aug 14 02:32 PM
    Thanks Jack.
    Thoroughly enjoyed your article, and look forward to your future blogs.
    Very curious as to your thoughts about COS and BQI
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  •  
    Aug 14 04:15 PM
    The recent management issues at PWE are upsetting to say the least. One would have hoped with so much cash available due to oil spiking, they could've jumped upon the opportunity more wisely. I took a long position in PWE early in 2008 and missed my opportunity to take my profits off the table when they were flying high barely over a month ago. Now, I wonder if I'll be stuck with a dog for some time.

    Although the dividend returns are enough to keep me happy, I don't like the idea of having a large position in a company whose management I have little faith in. That being said, I love Canroys -- but my questoin is which ones have stronger management and take shareholder interest to heart?
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  •  
    Aug 14 04:17 PM
    So it seems there is agreement that PWE has management issues - but which of the Canroys is well-managed? I hold a large long position in PWE and would sleep better at night if I was vested in a company with better management.
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  •  
    Aug 14 05:24 PM
    Just my two cents but I believe ERF and BTE are the best managed CANROYs. In the USA I would say PBT and SJT are the best of the bunch.
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  •  
    Aug 14 05:24 PM
    Like many posters on this thread, I have been investing in energy since about 1980. Jack, I very much appreciate your thoughts and viewpoints. We need dependable liquid, or possible gaseous, fuels for transportation for the foreseeable future. In spite of all the clamor, "alternative"... fuels seem to be over the horizon baring a stunning breakthrough. Conclusion: oil is going to be indispensable for our lifetimes.
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  •  
    Aug 14 05:30 PM
    Mr. Yetiv, thank you for a good exposition. Weep for America...living in a dreamworld where Russian control of the Georgian pipelines does not matter, Pelosi as dictator stopping American energy independence, and Congress putting green before citizens lives and lifestyle.

    The geopolitical forces are at work on oil prices. Canada with secondary and tertiary recoveries is a great blessing to the States. Canroys make lots of mistakes, but get bailed out by high crude prices. At their worst, most are still good investments. The old "businessman's risk" as Forbes Mag. used to say.

    Thanks, write more.
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  •  
    Aug 14 06:28 PM
    Well - MR. Yetiv - I don't know Mr. Paultaut - but he and I do have at least one thing in common. We both have now criticized you for not admitting to your bad calls. The last time I did so it was on the subject of your pumping TSL from the 40's all the way down to the 20's - to which your inane response as something to the effect that your original recommendation was at the time when it was at $15 or so (whatever the hell THAT has to do with my point). You also wanted to know where was MY analysis. This may come as a shock - but all readers on this forum are not contributors - nor are they required/expected to be. That does NOT disqualify any of us from being able to recognize POOR analysis when we see it.

    You have chosen to pump two companies that the majority of readers agree have p-poor management, one company whose share price has tanked, and a second that has declined rather than shown any tendency at all to ascend to the levels you have predicted.

    You talk a good game - but the bottom line is...you're damned poor at picking winners - at least for the ones you talk about here.

    As for your supporters....they appear to be no different than the many lemmings on other forums I've observed following their perceived "gurus" right into the abyss...
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  •  
    Aug 14 06:50 PM
    This blog isn't about me defending my "calls" as wsigler and paultaut appear to think. My goal when I write here is simply to share my analysis based on facts. I believe I have achieved that goal in my writing. If I have not, tell me what I have missed.

    What characterizes both of these writers is they criticize me without explaining how (1) either my facts were wrong, or (2) my analysis was wrong, nor do they tell us how THEY have done in their investments in the past year during which both the Nas and the Dow have dropped about 20% and the financial system has nearly imploded twice.

    In fact, contrary to paultaut and wsigler's assertions, the recommendations they complain about which I have made are UP more than 10% percent in the past year, which is FAR better than most money managers have done in the past 12 months.

    CSIQ is up about 60% from where I recommended it, TSL is down about 35%, SOL is up 25% from where I bought it about 2-3 weeks ago, PVX is up about 6% from where I bought it about a week ago, and PWE is down about 7% (but given dividends, I'm about break even).

    And TSL announces earnings this coming Mon, while SOL announces Tues. Let us reevaluate my performance on Tues.

    But even if their criticisms about my "terrible" stock picking were not factually incorrect, I find paultaut's and wsigler's comments useless unless they tell me (and everyone else) where I went wrong--ie, where my FACTS or ANALYSIS were wrong A PRIORI (not after the fact).

    With all due respect to the "consensus" here, I remain very comfortable with a stock (PWE) that is yielding 15% and is extremely likely to continue to do so unless oil goes below $80 and gas under $7.50. If any of the criticizers have a better idea than parking money in a stock that will return 15% almost guaranteed, speak up, I sure want to know about it.

    Jack

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  •  
    Aug 14 09:23 PM
    I have FRO, PWE and PGH in an Ing Sharebuilder account. Each month I buy a specific dollar amount of each stock regardless of the price and all dividends paid are reinvested back into the stocks. I have three other brokerage accounts and this one is the only account I don't fret over when the going gets tough. Now that I think of it maybe this is what I should be doing with all of my money so I can have more time to surf and mountainbike.
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  •  
    Aug 15 12:28 AM
    When PWE was at $33-34 you were pushing it for a 50% gain, the reason given was that they would have a blow out quarter based on your Cash Flow analysis. At the time I said that if I could get out above $40, I would be very pleased since I considered management's takeover of PetroFund to have been misleading, They were supposed to do a spin off, they didn't. I said I wouldn't buy shares until they dropped to the $28 level. I did not crow about this.

    I stated that HTE had better prospects for the future. You Slammed My recommendation because YOU said that HTE had a payout above their cash flow. On an operational basis before a non-cash charge, the payout was around 73%, try reading a quarterly once in a while.

    You want facts, start reading financials every once in a while.

    You own PVX, great stock. Lousy payout but great perceptive management. They own an East/West transCanada pipeline and a GTL facility. They bought it a few years ago.

    Please tell me who they bought it from and the details of the Contract which came with it.

    BTW, weren't you pushing FSLR just before their recent quarterly. You dismissed my comments about an overcrowded market and a Nosebleeding PE.

    When earnings came out and aftermarket trading kicked in, you started crowing about the aftermarket trades and tossed in that it would move $30 above the $20 it did in the after market. It closed unchanged the next day and prompty dropped another 10%. If something doesn't go your way, You never mention it again. But you are very, very quick to take credit.

    There is no "balanced approach" in your vocabulary.
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  •  
    Aug 15 12:47 AM
    BTW, regardless of the bickering, it doesn't really matter how PWE manages to continue its payout as long as it does. And the only CanRoy I am currently avoiding is AAV. PWE has reached the upper level of my buying range but not there quite yet.

    HTE is upgrading its refinery and PVX has cash to play with.

    Someone made a comment about oil sands making a profit at $40 brl oil. No longer, the time frame for that is long gone, expenses for everything are up dramatically. At the time Nat. Gas was what $2.00 per MCF? Replacement parts, shipping costs, labour, you name it. And Environmental Costs are kicking in. I haven't followed this very closely.

    But would appreciate knowing what current operating costs per brl. actually are.
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  •  
    Aug 15 08:44 AM
    Has anyone read about the Commodity Futures Trading Commission article in Reuters on Aug 5, 2008 where the CFTC is FINALLY doing their job?

    Speculation in oil futures is beginning to get exposed. Go to:

    www.stopoilspeculation.../

    to see what companies are upset with the high cost of oil, gasoline, jet fuel, diesel and home heating oil. There is demand destruction and speculators are being investigated.

    Don't think that people will just keep on making OPEC, Big Oil and Speculators rich.

    I am sorry that these facts are misunderstood by a lot of folks.

    Do you wonder why so many people thought they could speculate in real estate and not get burned?
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  •  
    Aug 15 11:25 AM
    Jack, in June you said if oil stayed above $120 that PWE would have a blowout quarter. Oil did average over $120, but PWE did not deliver a good quarter. Can you provide some insight and analysis into PWE’s results, and discuss specifically why they did not make the numbers you were expecting? Thanks.
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  •  
    Aug 15 11:47 AM
    Keep up the pressure herve, eventually he might have a reply which doesn't involve deflecting the questions.

    The Onus is on you JY. You did the analysis, You made the Call. What did you call it? A Priori? Lets hear about your reasons before the fact.

    I certainly did not go along with your reasoning before the Release. Technically, it looked like it could have moved above $40 and I was really hoping you could get enough people to buy it and drive it up so I could justify getting out. It was overpriced at $34, it is more reasonable now.
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  •  
    Aug 15 12:59 PM
    J.Y.: "where my FACTS or ANALYSIS were wrong A PRIORI (not after the fact). "

    That's easy. "The proof is in the pudding".....and "the pudding" we're talking about here is the price behavior for the stocks in question. Compiling some facts and doing some analysis is clearly inadequate when it's obvious you overlooked/ignored some critical facts and limited your analysis to only a portion of relevant factors. Which facts? What factors? I don't know (but for some of the comments made by others who don't count themselves as your rabid fans)...but that makes no difference. Had your facts been all inclusive and your analysis complete, you would have reached a different conclusion - one that was consistent with the price action on these securities. I suspect overall market conditions and sector rotations were not among your considerations....and I fully expect this to be confirmed - again - when we observe TSL price action post next earnings....
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