Tesco PLC: How Spread and Ratio Trading Helped Me Unwind A Position Months Before the Stock Crash

Whenever we talk to people about spread trading, most of them think it is something related to statistical-arbitrage, mean-reversion and pairs trading.  While this is true, for me there’s more to spread trading than stat-arbitrage.  For me it is also a valuable tool for measuring the relative value of a stock against another stock.

Let me give a recent real-life example here. 

The first chart you see below is the ratio of Tesco PLC/Sainsbury’s PLC. These two supermarket giants are headquartered in the UK.

Around February-March 2011, you can see from the chart that TSCO.L was looking very cheap compared to SBRY.L. I decided to purchase shares of TSCO.L at £3.79/share on the 17th of March 2011.

After a few months, I checked the ratio again. TSCO.L was looking expensive relative to SBRY.L as if it was telling us to get out of TSCO.L and Buy SBRY.L. I trusted the Math here.  I decided to Buy some SBRY.L shares at average price of £2.68/share in late September and unwind all my TSCO.L position in early October at £4.06/share for a 7% return. 


Today the share price of TSCO.L is hovering around £3.13/share. It crashed nearly 19% in three days after the company reported a sluggish Christmas Trading. £5 Billion was wiped off the value of Tesco Plc. I must say I got very lucky for getting out in October thanks to the ratio chart. Otherwise my Large-Cap Portfolio would have been treading water. 

I've been using the ratio tool and the spread analyzer to compare other equities that operates in similar market or sector especially before the earnings season. There's plenty of names out there ORCL/MSFT, AMZN/AAPL, GOOG/BIDU, NFLX/BIDU, CROX/SKX etc. You'll be surprised what this tool will reveal!

When the ratio reaches the bottom blue line on the first chart, I’ll add TSCO.L in my medium term portfolio. Michael Bigger termed this area as “Fat Margin of Safety”. 

Michael Bigger illustrated this in his book “In Praise of Speculation”.

“..let’s plot the trajectory of Stock1 and Stock2 versus time (Figure 1). Let’s assume both stocks have an identical intrinsic value term structure. According to Figure 1, a trader who uses a value framework for making investment decisions would buy Stock2 and sell Stock1 at time t1. .”

Statistical-Arbitrage Comparison (Dollar-Neutral)

The second chart below is the spread +10 * TSCO.L - 13 * SBRY.L.  In our book, when we spread two securities, we also measure the standard deviation from the mean of the spread. A 2 standard deviation below the mean is considered an oversold spread i.e. TSCO.L is cheap relative to SBRY.L. A 2 standard deviation above the mean is considered an overbought spread i.e. TSCO.L is expensive relative to SBRY.L. Standard deviations are shown in the third chart. 

We can map the spread and their equivalent standard deviations at time t as can be seen below:

-1000pts ~ 2 Standard Deviations below the mean of the spread at t = March 2011

200pts ~ 2 Standard Deviations above the mean of the spread at t = September 2011

Now around March the spread was trading at 2 standard deviations below the mean. If one bought the spread here: Long 10 * Shares of TESCO/Short 13 Shares of Sainsbury's at -1000pts and got out in September at 2 standard deviations above the mean at +200pts, the profit would be +200 - (-1000) = 1200pts per spread. 

Written by Aris David. Follow me on Twitter and StockTwits.


Every Single Day

I am reminded to repeat the following mantra for a few minutes:

Avoid the Mediocres

Today, the beat goes on with Barnes and Noble (BKS), and of course Eastman Kodak (EK).

Written by Michael Bigger. Follow me on Twitter and StockTwits.


Metrics for a Good Business: Current Earnings or Platform for Future Earnings?

Legendary investor Bill Ruane said this about good businesses:

The single most important indicator of a good business is its return on capital. In almost every case in which a company earns a superior return on capital over a long period of time it is because it enjoys a unique proprietary position in its industry and/or has outstanding management. The ability to earn a high return on capital means that the earnings which are not paid out as dividends but rather retained in the business are likely to be re-invested at a high rate of return to provide for good future earnings and equity growth with low capital requirement.

Based on his description, ($AMZN) is a good business. It has high returns on capital. Look at the stock price trajectory since its IPO. It is up about 200 times. In addition, $AMZN is drowning in reinvestment opportunities.   Yet, when the company puts capital towards these investment opportunities, GAAP requires that they be classified as “operating expenses”.  As a result, earnings are negatively impacted and the bears come out to sell.

$AMZN confuses the heck out of investors. How should we classify the investments it makes in its own platform? Are they capital expenditures or operating expenses? Jeff Bezos’ 2010 annual letter to shareholders shed some light on the subject. Here is what he had to say:

All the effort we put into technology might not matter that much if we kept technology off to the side in some sort of R&D department, but we don’t take that approach. Technology infuses all of our teams, all of our processes, our decision-making, and our approach to innovation in each of our businesses. It is deeply integrated into everything we do.

At $AMZN technology is an integral part of operations, current and future.. Current earnings are depressed because some of its operating expense are investments that will generate payoffs 3 to 5 years down the road. Current earnings suffer but the platform value compounds nicely over time.

Cash, earnings and the business platform are all economic assets. In the case of $AMZN, Jeff Bezos is clearly investing in the platform for the long term. Bezos is doing the right thing.

Written by Michael Bigger. Follow me on Twitter and StockTwits.


Taming a Wild Croc


I got kicked very hard in my investment portfolio after $CROX pre announced earnings that fell short of expectation. It is hard to escape when an investment drops 40 percent in a matter of second.

The company’s announcement about 3rd quarter result was not so bad but the 4th quarter expectation is nothing to write home about. CROX’s management is encountering some resistance in its effort to turn the company into a 4 seasons shoe provider.

The stock is currently trading at about 10 times earnings and until growth returns, I doubt very much the stock will be moving much from these levels (mid teens).

I could easily give up on the company and move on to greener pasture. That is easier said than done. I find it hard to find great companies worthy of my money and trading at reasonable valuations. Yes, there are many cheap companies out there. Cheap only is not good enough for me. I crave greatness.

In the light of this earning revision, I must revisit the thesis that CROX is a great company with strong growth potential.

In order to answer this question, I focus on the success factors that will not change in the future. I focus on the constants. In a changing environment you must focus on the things that do not change. That is a trick I learned from Jeff Bezos.

Here is how I think about CROX’s greatness and its potential future:

• Comfort. Customers buy Crocs shoes for their comfort.
• Crocs are still the best-sellers shoes on The product resonates.
• Deep internet product genetic (rating, reviews, etc.).
• Retail space expansion at 20% clip for many years to come as bulldozes retailers around the globe, freeing prime retail space for the retailer winners (Apple, Crocs, etc).
• No debt.
• Well managed.
• Inventory under control (that is the biggest risk).
• Pace of innovation unabated (Chameleon, Translucent, new retail concept, etc.).
• Persistently strong backlog outside of 4th quarter.
• Design capabilities.
• Weight of the product. Shipping advantage.
• High return on capital.

For these reasons, I bought more shares on the selloff and I have no intention of selling my shares. CROX is an exceptional company. It rarely pays to sell an exceptional company until it loses this characteristic.

What do you think?

Written by Michael Bigger. Follow me on Twitter and StockTwits.


The Mighty Constant

On August 19, a respected market analyst added Crocs (CROX) to his top stock pick recommendation list. In his research report, he noted that Crocs is a different company today than it was during its faddish days. I buy this argument but…

It is also true that CROX is similar in one very important way. Since its inception, Crocs has always been in the business of providing foot comfort. That is what CROX does day in, day out. This is the reason why people buy its ugly styles. Yes, the outer shell of the business is different but the essence is still the same. And by the way there is much more to Crocs offering than the few ugly shoes.

For CROX, comfort is the mighty constant.

This post is not about Crocs however. This post is about the importance of the mighty constant in our speculative activities. The CROX example illustrates very well how a stock price and the crowd’s perception of a company can vary wildly while the core essence remains constant. $CROX was in the business of providing foot comfort when it was trading at $70 and it was still in the business of providing foot comfort when it was trading at $5 and lower. Now that it is trading at $27, the same constant is there, unwavering.


In a fast-changing situation such as the $CROX stock price trajectory, your ability to extract energy (money) out of a system depends on your ability to identify the mighty constants and manage your speculative thesis around them. If you manage your thesis to what is changing and not to what remains constant, you will compound return negatively. Many investors will buy when the media screams BUY, only to sell when the stock price collapses.

Managing to what remains constant creates a profit beacon. The path leading to the beacon is a compounding machine.

Jeff Bezos said this about change: “It is important to focus on what’s not going to change in the next five to ten years.” Amazon customers want lower prices, increased selection, and fast and free shipping. This will never change.

Ask yourself what’s not going to change in your speculation. Build your strategy around that.
A list of my favorite constants follows:

  • Overreaction to news already factored in. Investors and traders overreact.
  • Stocks fluctuate: they are volatile.
  • Ibbotson’s Law of One Price: “two investments with the same payoff in every state of nature must have the same current value.”
  • If you see a roach in the cupboard, you will find many more: Cockroach Theory.
  • Stocks are manipulated.
  • In aggregate, diversified portfolios track the market return minus some.
  • In aggregate, if a stock move after an analyst makes a recommendation, the move should be faded.
  • In a Levy flight news cluster, most sharp moves are erroneous.
  • Intrinsic value has a much lower volatility than its corresponding stock price.
  • Traders, when trading, behave like animals.
  • Efficient market hypothesis: the market is information efficient. EMH does not mean securities are priced right.
  • Positive information about a security takes more time to be reflected in stock price than negative information.
  • Shelby Davis's Law: “A purchaser of common stocks makes most of his money in a bear market; he does not know it yet.”
  • Corollary to Shelby Davis's Law: A seller of common stocks creates most of his value in a bull market, but he does not know it yet.
  • Customers are more truthful than management.
  • When opinions are diverse, stock prices reflect fair value.
  • When opinions are similar, stock prices diverge from fair value.
  • Investors are fickle when they lose money.
  • The purpose of media is to sell advertising. 
  • And so forth…

 Anything else I should be thinking about?

Written by Michael Biggerauthor of How Traders Achieve Creative Flow and In Praise of Speculation!

Follow me on Twitter and StockTwits.


COCO Has Arrived

On Monday, January 10, I posted the following tweet about Corinthian College ($COCO):



$COCO reported earnings this morning and as expected they were nothing to write home about. The stock is currently trading just above $1.75, down about 95% from its all time high. Since the stock has reached my price target,  I have decided to listen to the company's conference call at 12pm. Just in case...


Written by Michael Bigger. Follow me on Twitter and StockTwits.


American Apparel Heating up?

We are analyzing a special situation with American Apparel ($APP). As background, $APP secured rescue capital from Michael Serruya and Delavaco Capital on April 26 to help APP avoid filing for bankruptcy. The company was able to re-negotiate the terms of their debt to avoid default provisions triggered when 2010 financial statements contained a “going concern” clause. As part of the agreement with Delavaco Capital, APP CEO Dov Charney has anti-dillution provisions whereby he can purchase additional shares if the stock price meets certain targets ranging from $3.25 and $5.25 beginning in 2013 (see below). At that time we initiated a small long position in the stock, and we have been monitoring the situation ever since. On July 1 APP announced plans to replace 2 of their directors. At that time we added to our position.

On August 8 $APP reported earnings for the quarter ended June. EPS was $0.00, which represents an improvement over both the June 2010 quarter and over expectations. The earnings report confirmed the positive sales numbers released on July. Sales for the quarter were flat relative to last year’s June quarter, $132mm. US retail sales were down, offset by an increase in international sales. In the commentary management tells us that the trend is positive, with comparable store sales increase of 3% in June and 4% in July. Margins increased to 54.5% relative to 51.6% in the prior year quarter. International growth and margin improvement show us that the company’s turnaround strategy is starting to work.

We think APP offers a good risk/reward profile, with high risk but higher reward potential. Trend in both sales and margins are starting to turn positive. Here are the main points:

● Serruya and Delavaco Capital bought 15.8mm shares at $0.90 per share in April. In July they bought another 8.4mm shares. They have the option to buy another 19mm shares at $0.90 before October 26, 2011.

● As part of the terms of the investment, CEO Dov Charney of the company has an anti-dilution provision. If APP reaches stock price performance goals of $3.25 by 2013, $4.25 by 2014, and $5.25 by 2015, the CEO receives a total of 39.7mm additional shares.

● Total debt is well-collateralized:

Long-Term Debt as of June 2011: Total $141mm
Revolving Credit Facility at Bank of America, $75mm, $56.5mm is drawn, due July 2012
Term Loan at Lion, $84.2mm matures Dec 31, 2013

Assets as Collateral for Debt (as of June 2011): Total $294mm
Cash $6.9mm
Accounts Receivable $17.4mm
Inventory $193mm
Property and Equipment $77mm

● The company may now have enough time to return to profitability before cash runs out. The current rescue investment is for $22mm immediately plus an additional $18mm over the next 6 months at the discretion of the investor, for a total potential cash infusion of $40mm this year. Total cash usage for operating activities was $32mm in 2010, although it should be noted that in 2010 the company reduced inventory by $37mm (20%). For the six months ended June 2011, CFO was negative $8.5mm, better than the first half of 2010 in which CFO was negative $23.7mm.

Written by Jennifer Galperin. Follow me on Twitter and StockTwits.


Watching Skechers After The Close

We have been watching $SKX for a little while and recently decided to take a small trading position.  Just a little over a year ago, $SKX was trading in the $40 range.  Since then, due to a bloated “Shape-Ups” inventory and the research that proved that, surprise, they don’t work if you are just sitting on the couch, it traded down dramatically, to the current level of $14.88.

As you can see from the chart, $SKX is extremely volatile with several wild price swings in its history.  We think its current valuation is  low, particularly given its low debt and solid revenues.

Recently Michael Moore analyzed the stock price in his blog.  His research shows that the stock may be underappreciated based on the current Zscore.

Turning to the short-term chart, SKX is in a downward trend.


After $SKX reported earnings in late April, the stock traded down from above $20 to under $14 just a few weeks later.  We think the stock is ready for another big move.  The earnings report due out after the close today just may be the catalyst the stock needs to break out of its current range.  Competitors $CROX and $NKE also report tonight and $DECK tomorrow afternoon. The stock is not a good investment vehicle but it offers plenty of trading opportunities. There is no need to hurry on this one, we think the price action after the company reports earning might provide a clue about the next big move.

Written by Jennifer Galperin. Follow me on Twitter and StockTwits.


My Big Insight on Crocs

True the $CROX Chameleons are flying of the shelves, but do not discount this as well:
Click image to enlarge.

You see, the uglies are still selling like hotcakes. Crocs is located at the intersection of comfort, design, and a massive global retail arbitrage opportunity.

The beat goes on!

Written by Michael Bigger. Follow me on Twitter and StockTwits.


Crocs in a Nutshell


As Crocs (CROX) introduces its Chameleon shoe line and its upgraded Prepair line, I am impressed by the evolution of this company from:
• a global marketer of its comfortable iconic clogs;
to a company delivering to customers the following value proposition:
• innovative, well-designed, and comfortable shoes;
facing a gigantic opportunity driven by its:
• wholesale business,
• Internet business, and
• retail business, with an opportunity to exploit commercial real estate weaknesses to deploy its footprint globally over the next fifteen years;
• a terrific customer mindshare, resulting in the top brand with a pole position on’s shoe best-sellers list.
This company is facing a very bright future.