Boring Portfolio

Boring Portfolio Report
Friday, October 17, 1997
by Greg Markus (TMFBoring@aol.com)


ANN ARBOR, Mich. (Oct. 17, 1997) -- Disappointing earnings from selected technology leaders coupled with rising interest rates to stagger the stock market Friday. An ambient hum reminding us that Sunday marks the tenth anniversary of the '87 Crash added a dollop of skittishness. Although the benchmark averages recovered noticeably in the last hour of trading, the S&P 500 fell 1.16% and the Nasdaq tumbled 1.93%.

The Boring Portfolio plummeted 2.33% in value as all nine holdings slumped. Remarkably -- well, not remarkably at all, actually -- there was no real news on any Borefolio holdings. Nor for that matter was trading volume in any of them particularly heavy. This was simply a case of an insufficiency of buyers willing to step in front of a southbound freight. Thus far this year, every dip has attracted hordes of bargain hunters. Whether the pattern repeats itself this time is something we'll find out next week, I suppose.

However interesting days like Friday are for students of human behavior -- and I, for one, find them fascinating -- they are of little consequence to the Boring Portfolio. Its mission is to invest in reasonably-priced stocks of exceptional companies across a range of industries ... and then do nothing, unless either the fundamental story changes for a company or the price of a stock shoots well past any plausible conception of fair value. From that perspective, nothing at all happened Friday for Borefolio holdings.

Despite setting another new high on Monday, the Boring Portfolio dropped 3.73% for the week. That compares with losses of 2.36% and 4.15% for the S&P 500 and Nasdaq, respectively. During that week, two Boring companies reported their third-quarter results.

CARLISLE COMPANIES (NYSE: CSL) earned $0.63 per share, up 26% over the year-ago period and three cents above analysts' consensus expectation. Sales increased 25% to $316 million. Not to be outdone, GREEN TREE FINANCIAL (NYSE: GNT) posted quarterly earnings of $0.85 per share, up 39% over the year-ago period and two cents ahead of the consensus forecast.

Summaries of both companies' follow-up telephonic conferences are available for your perusal in the Conference Calls section of The Motley Fool. As you will see, both Carlisle and Green Tree anticipate continued strong profits in the current quarter and beyond.

Next to report is TIDEWATER (NYSE: TDW), on Tuesday morning, Oct. 21. We'll be covering that company's conference call for you, as well. TDW ebbed $1 15/16 Friday, as part of a weak drilling and marine services industry ... but then what industry wasn't weak on Friday?

Getting back to Green Tree, should you look at the company's press release, you'll see that a bit over $200 million of Green Tree's $348.3 million in quarterly income derived from something called "gain on contract sales." Since many individual investors -- and not a few analysts -- are unsure about just what gain on contract sales is, I thought I might offer a brief explanation.

Unlike banks or "thrifts," financial services businesses such as Green Tree do not have a ready source of capital from deposits. Instead, they raise capital by bundling up loans that they've made and offering for sale to investors -- that is, "securitizing" -- the stream of income the loan portfolio will provide as borrowers repay their loans over time. You may have read that rock star David Bowie did much the same thing not too long ago: he securitized the future earnings he'd be receiving from his composing, recording, and performing.

Anyhow, when Green Tree securitizes the loans it makes to finance, say, purchases of manufactured homes (MH), it retains the rights to service those loans and also much of the credit risk. For that, it expects to keep for itself a share of the income.

To take a simple example, suppose Green Tree made a bunch of MH loans at an average rate of 12%. These loans are then packaged and offered for sale in the asset-backed market at a "coupon" of, let's say, 9%. The three percentage-point "spread" is kept by Green Tree, and that's called the "residual."

That residual is not pure profit, of course. After all, Green Tree has to service the loans: collect the payments, dun the delinquents, repossess and resell the mobile homes in extreme instances, and otherwise manage risks of default and early prepayment. Whatever is likely to be left over after all those costs are factored in ... that's the "gain on sale."

Now comes the complicated part. According to accounting rules, companies like Green Tree record a gain on sales on the day the loan package is securitized. In order to calculate that gain, the company must estimate default rates, prepayment rates, and whatnot and discount back to present value the expected stream of income to Green Tree resulting from the "residual."

Even without following all the details, it's pretty obvious that there's plenty of room in this factoring and discounting for, um, "aggressive" companies to utilize various rosy scenarios in order to maximize their reported gains on sales. And just as they did not too long ago for a certain nation near and dear to our hearts, Rosy Scenarios have a way of eventually transforming themselves into Darkness at Noon. A quick look at the wreckage of a MERCURY FINANCE (NYSE: MFN) or a JAYHAWK ACCEPTANCE (Nasdaq: JACQE) will illustrate the point amply.

Happily, not all financial services outfits practice the accounting chicanery of a Mercury Finance ... or a David Stockman. Green Tree, in particular, has demonstrated to the satisfaction of the green eyeshade crowd at Standard & Poor's that it employs appropriately conservative assumptions in figuring its gains on sales. Historical results for Green Tree have shown actual gains to be in line with, or even occasionally greater than, those that the company had projected.

Thus endeth this week's lesson on "gain on sales." Happily, there's no exam next week, so I trust you'll put this autumn weekend to appropriate use.

Drip Portfolio -- Update, and valuing stock.
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TODAY'S NUMBERS
Stock  Change    Bid
ATLS  -1 3/4   25.50
BGP   -  11/16 25.69
CSL   -1       44.75
CSCO  -1 5/8   80.00
GNT   -  15/16 48.06
ORCL  -  3/16  34.19
OXHP  -1 15/16 70.44
PMSI  -  9/16  13.50
TDW   -1 15/16 62.00
                   Day   Month    Year  History
        BORING   -2.33%  -0.89%  25.94%  44.93%
        S&P:     -1.16%  -0.33%  27.46%  51.89%
        NASDAQ:  -1.93%  -1.12%  29.11%  60.13%

    Rec'd   #  Security     In At       Now    Change
  2/28/96  400 Borders Gr    11.26     25.69   128.21%
  8/13/96  200 Carlisle C    26.32     44.75    69.99%
   2/2/96  200 Green Tree    30.39     48.06    58.17%
  6/26/96  100 Cisco Syst    53.90     80.00    48.42%
  5/24/96  100 Oxford Hea    48.02     70.44    46.67%
   3/8/96  400 Prime Medi    10.07     13.50    34.08%
 12/23/96  100 Tidewater     46.52     62.00    33.26%
   3/5/97  150 Atlas Air     23.06     25.50    10.59%
 11/21/96  150 Oracle Cor    32.43     34.19     5.41%

    Rec'd   #  Security     In At     Value    Change
  2/28/96  400 Borders Gr  4502.49  10275.00  $5772.51
  8/13/96  200 Carlisle C  5264.99   8950.00  $3685.01
   2/2/96  200 Green Tree  6077.49   9612.50  $3535.01
  6/26/96  100 Cisco Syst  5389.99   8000.00  $2610.01
  5/24/96  100 Oxford Hea  4802.49   7043.75  $2241.26
 12/23/96  100 Tidewater   4652.49   6200.00  $1547.51
   3/8/96  400 Prime Medi  4027.49   5400.00  $1372.51
   3/5/97  150 Atlas Air   3458.74   3825.00   $366.26
 11/21/96  150 Oracle Cor  4864.99   5128.13   $263.14

                             CASH   $8028.59
                            TOTAL  $72462.97