July 18th, 2008

Lehman (LEH) and Fuzzy Statistics

I see much written about the possible bottom forming in financial stocks. For example, Doug Cass, whom you have to respect for his usual clear-headed thinking, was recently touting Lehman (LEH) for the following fundamental reasons in a theStreet.com piece entitled “5 Reasons I’m Long Lehman“:

  1. At $11, Lehman is selling at a value equivalent to its Neuberger and Berman wholly owned subsidiary.
  2. Lehman’s management is focused. The company has markedly reduced its leverage and ended second quarter 2008 with the lowest debt ratios in the brokerage industry.
  3. Deleveraging is continuing apace. Commercial and residential mortgage assets have been reduced by over 20% in the most recent quarter, and the company will likely reduce those exposures by another 15% to 20% by the current quarter’s end.
  4. Liquidity is in reasonably good shape as the brokerage has little dependency at this time on commercial paper or other short-term unsecured financing. Its secured funding has changed little.
  5. A combination of a $12 billion equity capital raise coupled with the deleveraging should allow Lehman to reinvest in other profitable business areas.

But what I find fascinating about LEH is the lesson it offers about volatility and the use/misuse of statistics. Over the past several days, all the LEH commentary was about its huge daily moves: 25.9% on Wednesday and 13.51% on Thursday. Yes, those lucky few who picked the bottom at 12.40 on Monday have seen a whopping 52.4% payday as it closed yesterday at 18.90. Not bad for a couple of day’s work. If we could only do that with all our money and do it only once each month then we’d be the ones with the $40 million estates and $6 million boats at Sag Harbor as paraded this morning on CNBC.

But wait, what if I been early at this “knife-catching” game and bought LEH prematurely at 19.74 the previous week thinking that was the bottom? Would I have kept my cool watching it collapse over the next several trading days to close at 12.40 for a 37% loss? As a matter of fact, there have been innumerable opportunities over the previous 18 months to buy LEH at what then appeared to be a bottom. Through out those 18 months, talking heads continually said it was undervalued and they’d be a buyer “if you either wanted to dollar-cost average or had a long-term horizon.”

LEH has fallen 77% from its peak in February, 2007. It’s going to take a while for a base to develop and positive momentum to begin. There’s a lot of headwind and many resistance trend lines to break through as LEH shareholders claw their way back out of this hole.

There’s only one thing of which you can be certain. While it’s declined 60 points from its peak to the current rebound price, it won’t, can’t and never will fall 19 points more. Yes, that would be 100% loss but also a pretty safe bet to never happen.

What we just don’t know is whether we’d have to sustain another 40-50% decline (and an opportunity missed to buy it at lower prices) and how long it would take LEH to go back to the 40’s area thereby generating a 100+% profit for those who buy today. I wish I had the spare change to make gambles with such high risks and high payoffs. But that’s all it would be, spare change like putting a dollar in a slot machine.

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