Finding support and resistance on a stock chart takes just a couple of minutes. You can make the annotations on your computer, or you can print out the charts and mark them with a pencil and ruler.

Three minutes of work can save you from making a mistake that would potentially cost you thousands of dollars.

Today, I’m going to make a few quick annotations to some of the charts you’ve sent in this week. I’ll then tell you whether I would buy or sell the stock in question.

Let’s get to it…

I purchased the Canadian stock Enerplus which is now down almost 50%…I know that natural gas is deeply depressed, probably resulting in the terrible drop of Enerplus. What I want to know is whether the stock has any possibility of recovering? Also, is it worth buying in more shares at this very depressed level?

— M.J.

Here’s a look at Enerplus Corp. (NYSE:ERF):

Sure, there’s a possibility that the stock will recover — at some point. But at this point, it’s important to get defensive. The market is falling, commodities are out of favor and this chart is terrifying. The breakdown in price accelerated in early April when ERF broke below horizontal support (blue line).

Also, I never recommend buying more shares just because a stock has dropped in price. It’s a dangerous tactic that’s more trouble than it’s worth. Don’t do it. The red line is resistance in this powerful downtrend. Even if the share price recovers to $16 from here, the downtrend remains in force. Yes, the stock is technically oversold. But it has been oversold since $21. It can easily move lower from here.

I’m thinking of buying 500 shares of Prospect Strategy Group (NASDAQ:PSEC). It’s a BDC. I believe this is a strong buy for at least the next 24 months. Could you give me your advice on this stock?

— J.P.

Prospect Capital has held up well during the recent market turmoil:

The stock has consolidated just below $11 since late February. On the chart, you can see how PSEC has registered a series of higher lows, indicating that buyers are stepping in at higher and higher prices every time the stock dips.

I can see why you’re interested in this stock. Judging by a quick look at the fundamentals, PSEC looks dirt cheap. It’s trading right at book value, its multiple is less than seven and I see plenty of insider buying recently.

In this case, the technical can provide a solid backstop to your fundamental research. Buying shares between $10.50 and $11 is not a bad price for a longer-term timeframe (you mentioned a 2-year holding time). I would also look to add a stop loss between $10 and $10.25. Look for this stock to break out if it can close above $11.25 on strong relative volume.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Reader Mailbag: Buy or Sell? was originally featured in the Penny Sleuth.

It doesn’t matter if you’re a long-term value investor or a short-term trader. When you’re dealing in stocks, timing isn’t everything — it’s the only thing.

As I was sorting through the mailbag this weekend, I found that many of your questions were about when to buy into a stock or a big investment idea. Today, I want to look at some of the potential trades and investments on your collective radar. I’ll analyze the charts and tell you if you’re looking at a solid buying opportunity — or a potentially disastrous trade…

Let’s get started:

What do you think of Cisco Systems (NASDAQ:CSCO) and Silvercorp Metals (NYSE:SVM)? Is now a good time to buy shares of both?

— S.R.

Here’s what Cisco looks like right now:

Yikes. Cisco is more or less a household name. But this chart is just awful. No one wants to own this stock — and with good reason. The company issued terrible earnings just last week — as evidenced by the massive gap down from $18.50 to $17.25. This gap will now act as resistance. So even though we’re seeing a decent rebound today to the high $16’s, I wouldn’t count on this stock recovering past the mid $17s anytime soon.

Any way you look at it, this thing is toxic. I would avoid it at any price.

Next is Silvercorp:

Here we see a very similar chart — minus the big gap lower. Still, a strong downtrend remains intact. Before you pull the trigger on an investment, draw a line connecting two or more peaks in the price. That’s where you’ll find resistance. Until your stock can break out of its downtrend, chances are it will continue to move lower…

Both of these examples could be considered falling knives. Neither CSCO nor SVM has indicated that it has put in a solid bottom. The important takeaway here is that an out of favor stock needs to time to consolidate after a move lower. Unless you see legitimate signs of life, the stock will probably see additional downside/sideways action before it begins to recover.

As far as questions go, I have one that may fall into your “it’s a bad stock, run away” category. Cameco (NYSE:CCJ), the world’s largest uranium miner. It got hammered after the accident in Japan, and I bought in about a week later. So, you can see what has happened since then. Personally, I still feel that nuclear power is an important cog in the energy machine, and I expect it to return. My question is: is that a rational view, and, if so, is it smart (for the long term) to even consider adding to the position?

— M.N.

Yes, you are expressing a very rational view. Unfortunately, there is nothing rational about the stock market.

Here’s a long-term look at Cameco:

I think you’re analysis is sound. Nuclear is and will remain an important source of energy. But this sentiment is not shared by the market right now. That’s your problem. While you are able to project a stronger future for nuclear energy, the market has yet to move past the events in Japan and the reactions that followed.

Solid analysis will occasionally produce substandard investment results. This is why timing is so important. In this case, you jumped back into nukes way too early. Think of it this way: the market continues to deal with the residual effects of the 2008 financial crisis to this day. And were’ only about a year removed from the nuclear crisis in Japan…

As far as adding to your position — I generally do not advocate averaging down. However, some longer-term investors are fine with buying more shares at lower prices in the hopes that the stock will eventually rebound. It’s more about your investing personality than anything else. As long as you can sleep at night without worrying about your portfolio, you’re probably doing something right.

Keep sending me your charts, questions and concerns to editor@pennysleuth.com.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Monday Mailbag: When to Buy Stocks was originally featured in the Penny Sleuth.

My portfolio has plenty of the first two categories. We have a handful of above-average utilities and energy stocks. But we have only one health care play. If you look at other income-focused portfolios, you’ll find a number of health care real estate trusts and pharmaceutical makers.

Now, we’re not unaware that changing demographics in this country and rapidly growing health care costs have made this a powerful sector. But the numbers are all wrong.

On the real estate side, there are still a number of issues concerning what the property should cost. So smart investors have to remain picky when it comes to hospital and retirement home REITs.

But when it comes to pharmaceuticals, we’re dealing with a whole other set of problems.

We have been covering the ongoing “patent cliff” in name-brand drugs for years now. Some $49 billion in annual pharmaceutical sales are at risk of losing their exclusivity.

And for a drug maker, that’s your most important asset…exclusive rights to make and sell your drugs.

This isn’t some far-off problem. Last year, industry leader Pfizer lost exclusive rights to Lipitor. That drug brings in — or, more accurately, brought in — more than $4.5 billion in annual revenues. That’s a sizable chunk of change.

Others have faced similar challenges. Eli Lilly lost exclusivity to Zyprexa — $1.9 billion in yearly sales. GlaxoSmithKline lost Advair — $4.7 billion in U.S. sales. The list goes on and on. There are also plenty of big drug patent expirations on the horizon. In fact, the majority of these problems are yet to come for most major companies.

Now that we are further along on this patent cliff, other potential plays are popping up. There is one company we recently released to our Lifetime Income Report subscribers…

Up until now, we’ve been a bit cautious to get into it, however. Its long and successful history didn’t give it a pass on this patent cliff problem. It was very much in trouble.

However, through all of this, the company still managed to generate $11.4 billion free cash flow and increase its earnings per share for the 28th year. It has been able to do that in face of some of the stiffest economic environments in history and its expiring patent issues.

And, it has ensured continued growth through their proactive portfolio transformations.

What really strikes us about this company’s approach is how, despite its long legacy, it refuses to be a dinosaur. Its current goal is to realize half of its health care revenue from products developed in the last five years. Considering the backward-looking industry it finds itself in, that’s great foresight…

Sincerely,

Jim Nelson
for The Penny Sleuth

A Crack at One of the Fastest-Growing Sectors in the Market was originally featured in the Penny Sleuth.

OLED display screens — short for organic light-emitting diodes — offer far greater energy efficiency, along with brilliant colors and durability.

I’ve seen video clips of mobile OLED screens being smashed with hammers and not looking the worse for wear. A standard LCD screen would shatter into dozens of shards. In addition, OLED allows for transparent and flexible screens, which opens up a new world of possibilities for display technology. CNNMoney’s site lists transparent screens as the big technology breakthrough of 2012, although they got the name of the technology wrong.

The visual aspects of a breakthrough display technology, however, are only part of the story…

Mobile devices bring additional challenges, requiring the application of additional technologies.

Mobile computing devices are, obviously, small. This complicates their use, since there isn’t much room to cram a display and keyboard interface onto them. As a solution to the problem, mobile devices have been dropping mechanical keyboards and moving to touch screens.

Screens are no longer just output devices. They are now input devices as well. Sharing input and output functions in the same physical space means display screens can be larger. That’s easier on the eyes. Touch screens are also easier and more intuitive for many mobile applications compared with toggles and trackballs.

Several types of touch-sensitive displays exist, but the most-popular variety today is known as the capacitive touch screen. A capacitive touch screen includes an insulating layer, like glass, that sits on top of a conducting layer. Current manufacturing techniques use indium tin oxide (ITO) for the conducting layer.

Touch screens allowing multiple simultaneous touches feature a coordinate grid layer of electrodes, which each act as a sensor. Since the human body conducts electricity, when the insulating glass layer is touched, a potential electrical difference is created between the finger (or thumb, as the case may be) and the ITO elements.

This electrical phenomenon acts as a signal that is sent to a microcontroller, which interprets it so it can be used to sense input by a device’s operating system. Microcontroller functions include receiving the raw data, cleaning up background noise, interpreting the size and shape of the touch and calculating the exact coordinates of the touch. Touch has revolutionized the mobile computing market.

So just how big is the touch market? According to Walker Mobile, a mobile display market analysis and information firm, the touch screen market grew from $1.5 billion in annual revenues in 2008 to over $6 billion last year.

DisplaySearch, another market analysis firm, forecasts this market to grow to over $22 billion by 2016.

The market is expanding rapidly, and this year, we also have some near-term catalysts to accelerate the touch screen business.

Microsoft’s Windows 8, for example, will feature increased support for touch screens. Microsoft’s new user interface, called Metro, is specifically designed to use them. I had a chance to demo the Windows reboot at the Consumer Electronics Show earlier in the year. It is a big improvement over Microsoft’s initial attempts to include stylus touch functionality in tablet computers.

With the launch of Windows 8, there will be a wave of new touch-enabled mobile devices at the end of the year. However, we’ll also see touch interfaces accelerate their move into traditional computers.

Intel, always a close Microsoft partner, revealed an Ultrabook reference design that includes the tech. Ultrabooks are a highly portable, high-performance segment of the notebook market that is being promoted by Intel. They are expected to post strong growth within the PC segment over the next few years and will be a huge driver for touch screen technology.

With continuing strong growth in touch-enabled smartphones and tablets, as well as new touch-enabled PCs, there is a huge opportunity for companies in the touch screen business.

The semiconductor industry has been going through a soft patch, but it isn’t expected to be touch-and-go for much longer. With Windows 8, touch-enabled Ultrabooks and flexible touch screens all starting to go live by the end of the year as well, it is a great time to start a position in the touch screen market.

Ad lucrum per scientia (toward wealth through science),

Ray Blanco
for The Penny Sleuth

Nothing Touches This Market… was originally featured in the Penny Sleuth.

A financial crisis brewed on Wall Street. No investment was safe from the carnage. Chris — who happens to be an old college buddy of mine — struggled to understand where he went wrong.

The next time we spoke, he recounted the horror of seeing his investment disappear in the blink of an eye. I did my best to commiserate. But I didn’t have much to say. After all, no one was safe from falling stock prices in 2008.

Chris wanted to know how to cope with such a big loss.

“What happens now?” he said.

I responded with a simple question: What are your investing goals?

Chris didn’t have an answer for me. He knew he was interested in the markets. He also knew he wanted to make money. But he never considered the specifics — or the process. Instead of fine-tuning an investment strategy, Chris was throwing darts. It only left him confused and unsure about his next move.

To be clear, Chris’ first mistake wasn’t investing in stocks in 2008. His mistake was that he did not have a plan. He never even considered it. He liked the idea of the stock market, but he didn’t know how to get started.

It’s absolutely crucial to trade with a plan. You have to set goals. And you must know how to achieve them. I receive countless e-mails every day from novice investors just like Chris. They want to get involved in the markets, but they aren’t sure how…

I have no idea how to develop a trading plan. I subscribe to several newsletters which recommend specific stocks, and then I choose ones that fit my values.

How does one develop a trading plan?

— M.S.

I understand that investors have many styles of trading plans. Are you able to share a simple but safe stock trading plan for the novice investor in your newsletter?

— R.P.

Today, I want to show you how you can avoid starting off your investing career on the wrong foot. I have an easy-to-follow plan that will help you dominate the market’s steep learning curve, giving you the confidence you need to invest in a way that works best for you.

Your journey will begin with the simple question I asked my old friend: What are your investing goals?

It’s a short question that requires a detailed answer. The first part of this answer is a litmus test that every new investor should consider…

Personality is Key

What are your investing goals? Are you interested in growing your account or preserving wealth? Do you like taking risks or do you play it safe?

This is how you begin to find out what part of the market you should concentrate your efforts. In truth, there are many ways to make money and protect your investments. Individual investors have made fortunes buying stocks, shorting stocks, buying options, dabbling in commodities and even investing overseas. The key is finding a niche that works well with your personality.

If you don’t want to actively manage your account every few hours, you probably don’t want to be a day trader. The same goes if you can’t sleep at night knowing that a chunk of your money is tied up in a riskier growth stock.

It’s all about your comfort level. When you figure out your acceptable investing risks, you will quickly narrow down your choices. Then, when you’re comfortable with your expected risks, you need to gravitate toward your interests.

Do you like looking at stock charts? If so, maybe technical trading will appeal to you. If you’d rather sift through financial statements, value investing might become your preferred game.

As with most choices you make, you’ll have a much better chance at success if you pick the techniques that best fit your interests. It’s that simple.

Who Has Time For Stocks?

The second piece of the puzzle involves the amount of time you can dedicate to the markets.

One of the biggest mistakes that beginners make is jumping into new investments without a set routine. If you’re working a high-demand job 60 hours per week, you won’t have time to make trades on your computer during the middle of the day. And if you can’t dedicate a few minutes on the weekends to keep up with the latest market-moving news, you’ll want to explore more longer-term investment options.

Conversely, if you have plenty of free time during the day, maybe actively trading stocks is right for you. But I must caution you — short-term trading of any kind requires research and discipline. Day trading is an especially risky proposition for a newcomer. Don’t jump into this discipline expecting to win right away!

No matter what your strategy, I urge you to paper trade before putting your hard-earned money on the line. Some online brokers even offer paper trade accounts to help you practice. These resources can be invaluable. I also recommend you keep a journal of your winning and losing ideas. This will help you begin to fine-tune your strategies. When the time comes to put real money on a trade, you’ll be confident and prepared.

Find the Right Resources

Finally, you need to know where to look for quality resources and tutorials. Find blogs or e-letters that offer impartial ideas and advice — like this one! Learn from more experienced traders and investors. And be sure to read the great standards of your chosen discipline.

If you want to get into trading, you should check out the personalities profiled in the Market Wizards series by Jack D. Schwager. If you fancy yourself a value investor, you should pick up a copy of The Intelligent Investor by Benjamin Graham. These great works will lead you toward new ideas and sources that will help you develop the strategies you need to find success…

One More Thing: Ask Questions!

Never hesitate to ask questions. You always drop me a line at editor@pennysleuth.com. Feel free to send me your questions, tickers, and charts. I can annotate the charts for you and give my honest feedback, tell you if a penny stock looks like a scam, or even offer some insight into different investment philosophies. I’ll compile the best questions into a “mailbag” section every week. This way, we can all benefit from the discussion.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Winning with Stocks Begins Here was originally featured in the Penny Sleuth.

Remember, this is before the company that will soon have the largest Internet IPO in history dropped the “The” from its name.

For one small investment firm, that’s exactly what happened.

Before anyone outside of a handful of university students even knew much about Facebook, a company called Accel Partners dropped $12.2 million on it.

On Feb. 1 of this year, after months of anticipation, Facebook finally announced its plans to go public. For Accel, that’s the equivalent of striking gold.

Even after selling 17% of its stake last year, Accel’s Facebook bet is still worth as much as $11.4 billion, according to Bloomberg. That’s a 934-fold return!

This makes for a great story if you’re the gambling type. But for every Facebook, there are plenty of losers.

Venture capital is a tough business. It takes an incredible amount of luck. That’s something Bahrain-based Arcapita didn’t have recently.

The private equity and venture capital-focused investment firm filed for bankruptcy two weeks ago after defaulting on a $1.1 billion loan.

This is just one of hundreds of stories about failed venture capital companies. And the vast majority of them have one aspect in common: They bet big on startups by buying equity stakes in risky industries.

Today, we’re going to show you how to be a venture capitalist without the risk.

Sure, you won’t be cashing out $11.4 billion on the next highflying tech IPO. But you won’t go the way of Arcapita, either.

I’ve pointed out before that small-to-medium-sized companies can raise money in only one of two ways: Sell shares or take on debt. But in today’s unique investment landscape, finding that funding is incredibly hard.

Raising money in the equity markets is always tough. And if you are dealing with a privately owned company, this becomes even more difficult.

Fewer and fewer private equity firms are willing to finance companies in exchange for ownership stakes. The numbers just don’t work out anymore.

Facebook is a rare exception. Most private companies don’t have the hype required to have a successful IPO. Fewer still have the ability to find backers pre-IPO…when they need it the most.

That just leaves debt. And in today’s strange debt market, no one is banking on risky companies. While that may be changing soon with the influx in junk bond investors, we’re still a long way from where we were prior to the recession. And for the companies we’re talking about, that’s simply not an option.

And forget about bank loans. Banks just aren’t ponying up the kind of small- and medium-sized business bank loans we used to see.

One of the main reasons is the collapse of the collateralized loan obligations. CLOs are basically just a way for banks to bundle these loans and sell them to investors. Investors haven’t been buying these products since 2007. This gives banks very little incentive to take bets on smaller companies.

So there is a huge credit gap globally for small businesses. They can’t find equity investors. And no bank will give them a loan.

There is a small group of publicly traded companies that finance privately owned companies. Again, they have the choice between equity stakes or loans. Increasingly, these financers are choosing the security of collateral-backed debt to the high-risk equity option.

These lenders are technically called business development companies, or BDCs.

This niche market is already showing my readers impressive gains One of my hottest plays recently is BlackRock Kelso Capital Corp. (NASDAQ:BKCC). It specializes in providing small to mid-sized cash-flow-positive companies with financing in exchange for debt or equity. The majority of its portfolio is made up of 73% secured debt, with 16% in subordinated debt securities and 11% in equity stakes.

As you can probably imagine, this relatively hidden industry has great upside.

In fact, because of an underreported budget hike by the Obama administration, plays like this could turn today’s credit gap into humongous income.

Sincerely,

Jim Nelson
for The Penny Sleuth

The Only Way to Close the Small-Business Gap was originally featured in the Penny Sleuth.

Last year, it was the hype around LinkedIn and Groupon. This year, it’s Facebook. Chances are you’re gonna get suckered. On average, studies have proven IPOs underperform the market by 30% in the three years after going public.

Here’s just one example: LinkedIn.

If you participated, you saw the share price climb as high as $122 on the very first day, before settling to $94 and a quarter. That’s a big jump from the $45 entry price.

However, most individual investors couldn’t see those gains. Institutions get first crack at IPOs. Those who jumped in after Day 1 have seen days of major disappointment when the stock traded as low as $59 and climbed back to only where it was bought at. So much for all the excitement…

IPOs mean buying something the insiders no longer want at a price they’d never pay.

Let’s not spend our valuable time lurking about in these statistics in The Journal of Finance. I see far better deals out there in the public offering markets right now. Allow me to share with you the one class of public stock offerings that I think are worth your time and initial investment.

You probably don’t hear about these — even though they routinely beat the S&P 500.

From 2002-March 2012, an index tracking this class of offerings beat the overall market by 226%. Look at recent history and you’ll find companies like American Express, Home Shopping Network and Marriott Hotels directly involved in these deals.

But despite these incredible returns, these offerings get none of the “hype” of IPOs. That’s why I call them “Hidden Public Offerings” (or HPOs)…

They’re hidden because they just don’t get the press that IPOs do, but they’re a great way to exploit inefficiency in the market to help you outperform in your stock portfolio.

How Do Hidden Public Offerings Work?

When company insiders want to maximize the value of an asset they own, they may chose to do so by “splitting off” a section of their business into a wholly separate business. You can buy shares in that new business. This is referred to as a spinoff or Hidden Public Offering.

I consider spinoffs to be hidden because they don’t jump off the investment shelves the way IPOs do. Often, the asset itself is “hidden” on the balance sheet of a company; it’s not the main item that attracts present shareholder interest. Yet the asset will have a real value on the open market (often not the same value it holds on the parent company’s balance sheet). A spinoff helps “discover” the true value of that asset.

There are several benefits to the company (and present shareholders in the parent company) when a new business is spun off of the old. The parent company and its shareholders retain equivalent shares in the new company. They can buy or sell the new shares as they please. New investors can get into the new company at a price they might not have paid for the parent company.

How Can I Track Spinoffs?

If you want to track these stocks as a group, follow the Bloomberg U.S. Spin-Off Index. You can find it under the ticker BNSPIN.

But there’s no super-secret spinoff “tip sheet” that shows you what stocks are planning on spinning off assets in the next, say, 12-36 months. That’s why Mayer’s Special Situations exists, to point out such choice one-time events to readers as these Special Situations develop. It’s not as if I can say to you right now here are the spinoffs, here are the dates, the tickers, have at it! It takes time and research and sleuthing… That’s what a balance sheet detective like me does best.

I sniff out assets that could benefit in the case of a spinoff. I also do as much due diligence on the CEO and the big company directors and other insiders as I can. I’ll even ring a CEO up on the phone. He won’t be able to tell me if there’s a spinoff in the works… but many times, you will find the suggestion or hint of these kinds of value-creating shareholder actions in a public SEC filing or quarterly conference call.

Even if you did have an advance “peek” at the Hidden Public Offering list of spinoffs, you still need to vet out the candidates for investment. As with IPOs, not all companies are good bets to take.

My excitement for spinoffs depends on what price the new company starts trading at and the particulars of the deal. The form I need to see for that is the S-1.

One spinoff to watch out for is one in which the company is spinning off an undesirable legacy business that just might not have a future they want to be a part of.

A case like this is Loews Corp. (NYSE:L). I like Loews because I like the Tisch family, a dynasty begun in true American fashion just after World War II. The Tisch brothers paid out $375,000 for an old New York hotel with help from their parents. They went on to snap up hotels in Atlantic City and Manhattan. In 1968, they acquired Lorillard Tobacco, using that steady cash flow to fund other operations and, most importantly, smart acquisitions. By 1995, you could have found the Tisch brothers on the Forbes 400 list of wealthiest Americans, at $1-2 billion net worth. Loews, their main investment vehicle, continues to deliver solid returns to this day. If you’d put just $1 into Loews in 1959, it’d be worth over $1,622 today. And that’s not even accounting for the dividends Loews paid out over the years.

They follow three simple investing rules:

1. Always assess the downside.

2. Invest in assets, not management.

3. Our day will come.

Now, here’s why I mention it. You can use these same rules to decide why it’s no longer best to keep hold of a business you own. In Loews’ case, the thing to jettison was Lorillard Tobacco.

Lorillard used to be Loews’ cash cow, funding acquisitions during down markets when other assets (like drilling rigs or pipelines) were cheap. But those heady Mad Men cigarettes-in-every-meeting days are long gone. As the legislation changed in America, and as sick smokers started suing, Lorillard became something of a “surprise litigation risk.” It wasn’t a business I liked for Loews down the road, and I was very happy the day they announced they were spinning it off.

Forget IPOs. Luckily for us, we’re in the sweet spot of HPOs.

Joe Cornell, a 15-year veteran in the field and head of Spin-Off Advisors reveals, “I don’t remember the spinoff calendar being this robust. This is going to be the biggest year ever for spinoffs.”

I also think this year could be a record-breaker.

What kind of market are we talking about? Well, 2011’s spinoff values were double what they were in 2010. Back in 2000, the spinoff record was $265.5 billion. That’s the one to beat.

Sincerely,

Chris Mayer
for The Penny Sleuth

Hidden Public Offerings was originally featured in the Penny Sleuth.

At Grant’s conference two weeks ago, the great short-seller gave the audience a half-dozen short sale ideas. I’d like to focus in on three of them. He called them “value traps” because they look cheap on the surface but have serious problems underneath.

You don’t want to own any of these ideas.

The first is the flip side of the shale gas boom. You know the outlines of this story already. New technology has cracked open once-unreachable natural gas. Gushing new gas wells have dropped North American natural gas prices to around $2. That’s a drop of over 50% from last year and 75% from five years ago.

Suddenly, cheap natural gas means coal-fired power generation is in trouble, as more switch to natural gas. U.S. coal prices are down 20-32% from last year, depending on where you are and what type of coal. Coal train carloads are down 18% from a year ago.

Chanos’ favorite short here is CONSOL Energy (NYSE:CNX). Thermal coal made up 45% of 2011 gross profits. Higher-grade met coal made up 38% of profits. On these coal assets, CNX competes with low-cost exporters from Australia, Indonesia, South Africa and Colombia.

CNX also has quite a bit of leverage. In the last three years, it’s barely produced any free cash flow. Might further drops in coal prices force a crisis at CNX? It seems the Street’s opinion of what CNX will earn is changing rapidly. Just 90 days ago, the consensus was $3.19 in earnings per share this year and $3.62 next. Now that consensus is $2.08 and $2.63, respectively.

Avoid coal stocks in general and CNX in particular.

The next idea was national oil companies, which Chanos pointed out, “are being run for the benefit of the states.” The general model for a national oil company is for the government to retain a big stake in the company, push for costly investments and keep prices at the pump low.

The short idea here is Petrobras (NYSE:PBR), the Brazilian oil company that found the big pre-salt deposits to much ballyhoo. PBR seems a good-looking value story on the surface. It has a forward price-earnings ratio of only 7.5 times. The stock price is down 40% in the last two years. And it has, to its credit, the biggest oil find in the Americas in a generation.

Yet these mask serious problems…

Chanos points to the enormous (and risky) capital spending program out to 2015 — a $225 billion commitment that will require $14 billion in divestitures and $86 billion in additional debt.

Meanwhile, the government pushes PBR around for its own political reasons, like a kitten with a ball of yarn. So there are price caps at the gas pump, thereby capping PBR profits. PBR also must source 65% of its services domestically, handcuffing it in finding the best deals. And finally, PBR is building a huge fleet of ships at a time when there are already too many ships.

As Chanos showed, the end result of all this social engineering is some very poor results. For starters: Production growth of only 1.4% per year from 2006-11 and $13 billion in negative cash flow after dividends in 2011.

I will add here that I think the whole country of Brazil is in a bit of trouble. Longtime readers will not be surprised, as I’ve been warning about Brazil for more than a year now. Let me recount just some of the ways it alarms me:

Brazil’s tax burden is among the highest in the emerging world. It’s comparable to France or Norway and not competitive with its emerging market peers

Government spending is nearly 40% of the economy. Brazil already has a welfare state it can’t afford

In the ease of doing business surveys, Brazil ranks 126th out of 183 countries. That’s an embarrassment. It’s easier to do business in Rwanda, Guatemala and Pakistan than it is to do business in Brazil

Infrastructure is poor and not getting much better. Poor roads and ports lead to long queues, spoilage and wasted time. Investment in infrastructure is only 2% of the economy, compared with the 5% emerging market average.

Crime is a big problem. No wonder Brazil is the world’s second-largest market for armored cars. Eike Batista, Brazil’s richest man, doesn’t go anywhere without a small army. This is normal among the elite.

Why people continue to think Brazil is a good place to invest can only be because of Brazil’s inherent sex appeal. It seems to have everything. My recommendation is go ahead, go to Brazil. Have a good time. Go to the beaches. Enjoy the caipirinhas. Then invest your money someplace else.

The third idea from Chanos that I’ll highlight is iron ore. As China has boomed, so has its demand for iron ore. China alone makes up 66% of global iron ore consumption. China’s boom has taken a ho-hum commodity and made it exciting. Take a look at this price chart:

How sustainable is today’s price? Already, Chinese demand seems to be flattening out. And as Chanos pointed out, iron ore is not particularly rare. You just have to dig it up and get it to the coasts, which is what people have been doing. There has been tremendous investment in rail and mines in the last several years. All of the major iron ore producers are ramping up production at a time when Chinese demand is flagging.

Chanos highlighted Fortescue Metals as the one he thinks will crater. Once again, it seems to have the outlines of a “value story” — it has high profit margins, low costs and plans to nearly triple production by 2013.

The problems: 98% of sales go to China, it has a high level of debt and it suffers from rising costs.

So those are a few ideas from Chanos. Don’t own coal producers, national oil companies or iron ore producers. And especially avoid CNX Energy, Petrobras and Fortescue Metals. I strongly agree with Chanos’ take on all three of these ideas.

This is also a good lesson in trusting obvious figures like price-earnings ratios. You can’t just look at surface appearances and expect to do well in stocks, except by chance. There is much more to handicapping the success of an investment than just looking at what everyone sees and knows about. Chanos proves that out with this suite of ideas.

Sincerely,

Chris Mayer
for The Penny Sleuth

Three Ideas You Don’t Want to Own Right Now was originally featured in the Penny Sleuth.

In the 1770s Italian physician and physicist Luigi Galvani shocked the world with the discovery that a spark could cause a dead frog’s legs to twitch.

In 1802, German chemist Johann Wilhelm Ritter furthered Galvani’s research into electrophysiology. He observed how halting a strong current in muscle nerves could cause a muscle to contract.

Electricity as a medical therapy became a high-voltage field of interest. By the late 1800s, scientific literature described how electrical pulses could kill bacteria in river water or change the shape and color of red blood cells. Luminaries, such as Nikola Tesla, pioneered experiments and patented electrotherapeutic equipment.

Although electricity’s effect on the body had long been studied by the middle of the 20th century, many of the mechanisms were not yet known. In the 1950s, however, this began to change. For example, in 1951 Nobel Laureate in physiology or medicine Alan Lloyd Hodgkin theorized that the breakdown of a cell’s “skin” was at the root of many of electricity’s observed effects.

Hodgkin believed cellular membranes were electrically insulating layers, and that strong electricity caused pores to permanently open. Irreversibly opening pores made cells break apart and die. The phenomenon was dubbed electroporation, from the words “electric” and “pore.”

However, more experiments by other researchers eventually showed that irreversible electroporation wasn’t always the outcome of passing electricity through cells. Cellular pores are electrically charged gates. If pulses of electrical energy are sufficiently low and brief, existing gates open only temporarily. These cells don’t die, but this effect can still be useful. With electroporation, the ability of cellular membranes to keep a tight seal to the outside world can be manipulated for short periods of time.

As it turns out, the discovery of reversible electroporation revolutionized biotechnology research. Cracking open a cell’s pores allows researchers to get stuff into cells they weren’t able to before. By the 1980s, thanks to reversible electroporation, researchers were able to modify genes in everything from mouse cells to bacteria.

Today, electroporation equipment is a standard appliance in research labs. These devices, called electroporators, are used to create things like “knockout mice” — organisms with genes modified to study everything from cancer compounds to Alzheimer’s disease. Moreover, many of the new wonder drugs are biologics, which means they are produced by living organisms. Biologics often depend on the use of electroporation to create genetically modified cell lines to manufacture complex therapeutic proteins.

Up until recently electroporation has been limited to the lab. It is something used to introduce molecules that normally won’t be absorbed by cells while in culture. But that has changed…

Today this same technology is being applied for the treatment of cancer in living organisms — humans, to be exact…

You may already be familiar with some of this technology. I’ve been writing about it for some time.

Therapeutic engineered DNA molecules, known as plasmids, are an exciting, maturing platform for treating disease.

Plasmids are small rings of DNA that are used to turn cells into custom protein manufacturing plants. Once introduced into a cell, these genetic code constructs act like native DNA: they guide the production of proteins. This can include therapeutic proteins. The downside of DNA plasmids as agents to cure disease, however, is that they don’t migrate into a cell’s interior very well, if at all.

Electroporation solves the problem of DNA delivery. It has been used for this job in labs for decades. It can increase the ability of molecules like DNA to enter cells by 1,000 times or more.

Electroporation drug delivery can be used for far more than DNA vaccines. It can be used to deliver DNA designed for other purposes, as well as for improving the uptake of therapeutic molecules that are already on the market…

One use of gene therapies involves injecting directly into tumors.

This focuses on writing the code for these naturally occurring anti-cancer agents in its DNA plasmids, and then introduces them into tumor cells via electroporation.

Normally, the immune system works to seek and destroy cells that develop mutations. Sometimes, however, mutated cells develop the ability to defend themselves by hiding from the immune system. Alerting the immune system with these signaling proteins allows the immune system to recognize cancer cells and triggers a cascade reaction to destroy them.

Early investors in the technology will be on track to reap rich rewards from breakthrough electroporation platforms… it addresses a huge market.

Yours for transformational profits,

Patrick Cox
for The Penny Sleuth

An Electrifying Biotechnology – A Shot at Shocking Profits was originally featured in the Penny Sleuth.

I wasn’t eavesdropping — I was simply finishing my meal at a local restaurant. Just as I was about to pay the bill, I overheard the conversation at an adjacent table turn to stocks.

At first, I didn’t give the comment much thought. Complaining about the market amongst friends sometimes happens after a few drinks. I was in no position to help, either. There’s really no way to casually insert your two cents into a stranger’s conversation about investing. So I signed the check and left, thinking that would be the last I would hear of it.

It wasn’t…

A couple of days later, I was on the phone with a stockbroker. I was asking a few questions about new features on his firm’s online platform. The rep was helpful and polite, and he had a few words of wisdom for me as our conversation came to an end.

“Don’t forget to buy low and sell high,” he said.

There it was again. The old Wall Street adage had crept back into my life twice in only 48 hours. I know it might seem like an innocent comment — but I am deeply bothered by the idea of “Buy low, sell high.” And I certainly don’t think an investment professional should be passing the slogan off to customers as if it were a can’t-miss nugget of stock market wisdom.

Whether you’re a novice investor or a professional money manager, you shouldn’t look to pattern your investment philosophy on the “Buy low, sell high” philosophy. After all, what does “Buy low, sell high” mean? More importantly, how does this Wall Street adage help the average investor make money in the markets?

In short, it doesn’t mean anything. And it won’t help you make money.

Instead of blindly following this tired Wall Street mantra, I have a better strategy to show you. If you have the guts to follow the spirit of this rule, you should have no trouble beating the pants off the market — and the “Buy low, sell high” crowd. But before I get into the details, I’m going to show you exactly what’s wrong with the conventional wisdom behind “Buy low, sell high” thinking.

When you were learning economics in school — or even when you first began to look seriously at the markets, the charts all seemed so clear. It’s simple to look back over the past 20, 30, or even 50 years and pick out the best times to buy and sell stocks.

With hindsight as our guide, it would be a no-brainer to buy stocks the day after the crash of 1987 and ride stocks through the bull market of the 1990s. Or sell our Nasdaq winners before the tech bubble burst and the markets tumbled in 2000.

But in reality, that’s not at all how the market operates. None of us can hop in a time machine with the hopes of buying a dead-certain market bottom. No one has the ability to look beyond the right margin of the charts.

This is precisely why “Buy low, sell high” is so meaningless. What is low? What is high, for that matter? And when do these mysterious opportunities occur? Not only does “Buy low, sell high” fail to answer these questions. It also gives bad advice at crucial market turning points.

As an example, let’s imagine a stock on your watch list just fell to a new 52-week low. Judging by our rule to buy low, buying this stock as it breaks to the downside is the perfect move. The entire objective is to buy shares on the cheap. Mission accomplished.

However, anyone with a shred of market experience will tell you that buying a stock as it posts fresh lows usually ends in disaster. You might be buying the stock for a low price, but you have to remember there’s no rule keeping your cheap stock from dropping even lower. In fact, a stock with enough downside momentum to make fresh lows is more likely to continue to travel lower before it finds higher ground once again. The company is out of favor, making it all the more difficult to attract new buyers. Instead of buying a stock at its true low, you’ve instead picked up shares of a stock that’s just beginning its decline…

On the other end of the spectrum, selling a stock at the high point can become even more difficult without the aid of hindsight to guide your decisions. If a stock you owned began making new highs, the sell high rule would kick in and you would have to prepare to take profits.

But why would anyone sell a stock that was trending higher? Unless the market gives you a reason to sell your shares and book the gains, it’s always a good idea to let your winners run. The same rules that affected our stock hitting new lows are in control of our stock that is making new highs. But in this case, you have an even better reason to hold onto your shares. You’re already sitting on open gains if you bought a stock that starts to move to new highs. Your risk is actually lessened because the investment has already moved in your favor. You have the opportunity to move your stop loss up to break-even and watch the stock outperform.

If you adjust your thinking a little, you can see how we could also justify replacing “Buy low, sell high” with the lesser-known trading mantra “Buy high, sell higher.” After all, it’s obviously a smarter decision to buy a name that’s making new highs than it is to sell an outperforming stock — even if you do have a longer-term holding time in mind.

It’s easy to see why you should forget the meaningless “Buy low, sell high” adage. It’s merely a catchy slogan masquerading as investing advice. Now, it’s time to get down to some true investing wisdom. I’m talking about a powerful, reliable strategy that has been used by some of the greatest investors in the world…

This strategy is simple to use because it relies on one of the most basic and important emotions affecting the markets: fear.

In his 2004 Berkshire Hathaway chairman’s letter, Warren Buffett penned a short segment that perfectly sums up how to use fear to your advantage when you’re looking to buy stocks.

“Investors should remember that excitement and expenses are their enemies,” Buffett wrote. “And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”

In my view, this is a decidedly better version of the buy low, sell high slogan. It’s much more actionable because the vagaries of price and time are replaced by a key market emotion. Instead of blindly guessing what an acceptable low buying price for a stock might be, you can gauge market sentiment to determine when fear has peaked.

Of course, this doesn’t mean you should jump on any stock that causes a panic on Wall Street. In order for this strategy to work, you have to wait for the panic to subside and the deep disappointment to set in.

It’s not enough to simply buy a stock when the price is “low.” You need a clear signal — a trigger that will tell you when to buy markets where investors have given up all hope. Every economic indicator (and every analyst) should shun the stock. The company, industry or sector you’re researching should be universally loathed. Negative news stories should outnumber the positive at a rate of 10 to one. That’s how you know fear has truly taken hold.

Once the scales have tipped and everyone has abandoned hope, you are left with an incredible opportunity. This is when the skilled contrarian investor makes his move. Everyone has already abandoned any hope of the stock going higher. No one is left to sell and push the investment lower. This is how turning points are formed.

In a sense, fear is the ultimate buy signal. If you have the foresight and the strength to buy when others are fearful, you will fill your portfolio with stocks that will deliver market-crushing returns.

Sincerely,

Greg Guenthner
for The Penny Sleuth

The Only Long-Term Investment Strategy You’ll Ever Need was originally featured in the Penny Sleuth.