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Hyperdynamics Takes a Hyperdive

Heav'n has no Rage, like Love to Hatred turn'd,
Nor Hell a Fury, like a Woman scorn'd.
-- From "The Mourning Bride," by William Congreve, 1697

I'm going to take exception to Congreve here and argue that scorned women have nothing on scorned story-stock shareholders. Evidence of this phenomenon followed the Jan. 14 publication of my cautionary article on Hyperdynamics (AMEX: HDY  ) . The comments I received over the next few days were generally nasty, condescending, or both. I was secretly short the stock or in league with short-sellers, said the critics. I was a clueless ass. I hadn't done any research. That kind of thing.

Well, today the stock is off roughly 22%, having tumbled as low as $3.75 from yesterday's close of $5.73 per share. I published my article on the day the stock hit its all-time high of $7.78. I must be very well-connected with nefarious market manipulators!

How we got here
To refresh everyone's memory, Hyperdynamics' stock price doubled from mid-December to mid-January. My contention was that this move was primarily driven by the announcement of a letter of intent with an unnamed independent E&P that would foot part of the bill for Hyperdynamics' proposed three-well drilling campaign offshore Guinea in late 2011.

My non-research told me that Hyperdynamics had seen a previous agreement with Repsol (NYSE: REP  ) fall apart. I floated the possibility of a repeat, stating that "if the current negotiations fall through, I expect the shares to take a dive."

That's exactly what has happened.

Did I call this one or what?
No, not really. I hashed out a valuation, assuming the letter of intent would be signed, and still found the shares to be on the fully valued side, given the frontier nature of the drilling program. But I at least considered the possibility of the letter not getting signed, and its implications for the share price. I have to assume most shareholders did not, given the sell-off today.

This is why we invest -- or speculate -- with a margin of safety. Speculators (and I don't mean that in a pejorative sense) may not feel like the concepts developed by luminaries including Benjamin Graham and Warren Buffett apply to them, but they do.

There's a right way and a wrong way to do this
Intelligent speculation, just as with intelligent investing, means buying at a discount to your probability-weighted expected value. In other words, buying a stock or other security only when the odds of making money are tilted in your favor. The problem, of course, is that predicting the future is tricky. Speculative odds are therefore incredibly difficult, if not impossible, to handicap with any precision. That leads many speculators to throw probabilistic thinking out the window, shrug, and say things like "Downside is only 100%." That is a mistake.

Here's a quick example. If you figure you have 1-in-10 odds of making eight times your money (+700%), otherwise you lose it all (-100%), your expected return is -20%. That's a bad bet. You'd require the prospect of making more than 10 times your money to expect a positive result, given the same estimated odds. Only the latter situation would qualify under Graham's definition of intelligent speculation, assuming the estimated odds were arrived at through well-reasoned analysis. (I recommend his lecture on the subject, which you can read at this link.)

The upside in a speculative investment like Hyperdynamics, or Rare Element Resources (AMEX: REE  ) -- all of whose rare-earth element resources are classified as inferred, and therefore geologically speculative by definition -- or Oilsands Quest (AMEX: BQI  ) -- an emerging oil sands outfit that's been emerging, rather than producing oil, for longer than I can remember -- is tremendously appealing to our sense of greed. Greed is good, but only when others are fearful.

There is a time and a place for speculation, but it's typically not when everyone's jumping on the bandwagon. In the case of Hyperdynamics, a subset of shareholders has a cost basis of under a dollar a share. Those folks arguably speculated intelligently, assuming they did their research, and can afford to ride out this setback for the company. Those waiting until the shares had tripled following BlackRock's investment at $2 per share, on the other hand, did not leave themselves an adequate margin of safety.

I'm all for sprinkling one's portfolio with a little speculation, but I encourage my fellow Fools to be smart about it.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 26, 2011, at 9:29 AM, HDYFAN wrote:

    Speculate cautiously. Buy fear, buy oversold technicals! IMO, do not underestimate Ray Leonard, ceo of Hyperdynamics, or Blackrock, a major financial backer.

    HDY could be over $10 pretty fast or could dip further, but the $100 per share upside remains, as HDY is going after BILLIONS of barrels of oil. The oil's not going anywhere. Shareholders come and go, but the shares are slowly getting to stronger hands, who are ready for the best wildcat play out there now. Investors/traders scared of drawdowns need not apply for this!

    When the next resource estimate is out, based on the recent 3D, you'll very likely see $20 per share as a more fair valuation for the underlying asset, 77% of the concession owned by HDY, the operator.

  • Report this Comment On January 28, 2011, at 1:02 PM, HDYFAN wrote:

    Isn't time to take a closer look at HDY now. Look a little deeper at the conservative estimate of 2.3 Billion barrels in just part of the HDY operated Guinea offshore concession?

    3D should identify more targets and higher odds for success going after the 2.3 Billion barrels or more. Now that all the exuberance has been knocked out of what was a toppy HDY chart, it's time to cover and go LONG HDY.

    At oversold, it's a good time to jump in. Water's fine. There's a whopper gap down on HDY at $5.40. That gap will very likely fill, soon enough.

    At the very least, the speculative/mad money side of a portfolio should have some exposure to those billions of barrels of oil.

  • Report this Comment On January 28, 2011, at 3:56 PM, HDYFAN wrote:

    After the bashing, comes the buying!

    Cover and/or go long HDY. Once you've done your DD on the ceo, the contract, the concession, geology etc, you will be optimisticly holding some shares thru the drilling process that starts later in 2011.

    Good luck. Good entry price here in my humble opinion.

    Long from the sub $ range and nobody's getting my stock.

  • Report this Comment On February 01, 2011, at 1:06 PM, HDYFAN wrote:

    HDY is having another great UP day. I wonder why?

  • Report this Comment On February 01, 2011, at 7:55 PM, HDYFAN wrote:

    TA for HDY now supports a very bullish slant on an editorial for HDY.


    Buy Confirmed.

  • Report this Comment On February 02, 2011, at 7:00 PM, HDYFAN wrote:

    $5+ HDY again. It's back. That was pretty quick, but with new 3D based resource estimates coming, HDY could easily be valued closer to $20 per share soon. Also, JV deals are being discussed, news could appear any time. $10+ HDY could then be showing on a screen near you soon.

    So, please short more shares of HDY, and you too could be kindling in the next real HDY rally.

    I can already see it. $10. $20. And possibly $100+ adjusted for forward splits some day after billions of barrels of oil are proven with HDY the OPERATOR. That's correct, Blackrock is a big backer of HDY, so HDY needs to remain the operator. Kind of nice that a firm like Blackrock has HDY's back!

    That's the vision of many investors who have been heavy in HDY since .23 lows and long before that. Many of us have 5 figure and 6 figure HDY positions at little or even no real cost from swing trading over the years. Most of us did NOT SELL on the the ol Bash-n-Buy routine that hit HDY at multi-year highs. Some sold some shares high and have already reloaded for even larger stakes in HDY.

    Jump on in, the water's fine. The more the merrier.

    All the best from Beavercreek Ohio.

  • Report this Comment On February 04, 2011, at 8:50 AM, HDYFAN wrote:

    Another day and no bullish editorial piece from Motley Fools in regards to the very nice rally underway in HDY shares.

    The headline on this piece is looking silly.

    How about some balanced reporting on the real upside with HDY!

  • Report this Comment On March 02, 2011, at 2:24 AM, Arizen wrote:

    About BQI - Strong Buy! About the 02/11 law suit its nothing but a joke they can not get clients as of Tuesday 03/01/11! The law firm behind the claim was still looking for clients to sign on to the proposed class action.....

    Check it out.

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