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Black Monday Case Study: ARCC

Topic: BDCs — ARCC
Aug. 27 2015, 12:25 PM ET - by VF member NAL (1039 gold star (click for information on feedback))

Black Monday Case Study: ARCC --

$11.01/share: That's the intra-day low for ARCC on Monday, August 24th.

At last report, ARCC had NAV/share of $16.80, turned in GAAP net income of .47/share, with .35/share of net investment income. The company declared a dividend of .38/share (which will go ex-div on September 11th), has an unbroken quarterly dividend history going back to 2004, survived the financial crisis and Great Recession without suspending its dividend, and has paid at least .35/share every quarter since 2006. I had last owned ARCC for an eight year period (selling in 2013 as posted here in July of that year), and have continued to follow the company. This week, I owned ARCC for a three day period.

Share count at quarter end was just under 314.5 million; closing stock price on Friday, August 21st was $15.39/share for a market cap of (314.5 million * 15.39 =) just under 4.8 billion.

Insiders have been buying the stock -- in fact, the CAO made a purchase on Friday, 8/21; the CFO made a purchase that day as well [
http://www.sec.gov/Archives/edgar/data/1287750/000110465915061739/xslF345X03/a4.xml and

But I bet they wished they had waited for the morning of August 24th! At the last "flash crash" I recall someone posting on VF that purchases representing a percentage decline beyond a certain threshold were canceled -- meaning that if someone had bought for pennies on the dollar thinking they got a steal, but then quickly flipped out of those shares on the rebound, they might have seen their purchase canceled but their sale left intact, leaving them short a rebounding stock. Keeping this story in mind, I placed a buy order for ARCC on Monday morning for $11.60 and it filled... but unsure whether this was "for real" or not, I made sure to hold those shares until I knew they "let me keep them." This morning there they were, still sitting in my account; I have just sold them. I offer this case study as another piece of evidence that Mr. Market is not always the rational, trustworthy, and respected individual many investors make him out to be when they rely on his ever-changing quotations for an ongoing indication of what shares of different businesses are worth at any second of any day the markets are open.

At $11.60/share, the market cap was (314.5 million * 11.60 =) just over 3.6 billion. If Mr. Market is to be believed, trusted, and respected, then he was telling us that on the morning of August the 24th, this company was worth 1.2 billion less than it was worth at the close on Friday the 21st. Keep in mind, no developments had come out of the company itself to explain Mr. Market's sudden Monday morning pessimism (the only recent "news" being the recent insider buying). If you believe Mr. Market is rational and his opinion is to be trusted and respected, then at $11.60/share, Mr. Market was "telling us" that ARCC was worth 69% of its last reported book value, and, that a 13.1% dividend yield was an appropriate level for this stock, on the morning of Monday, August the 24th.

How does Mr. Market feel today, Thursday the 27th? Mr. Market now says ARCC is worth 4.8 billion again. No news has come out of the company in the meantime (except more insider buying). I'm supposed to believe that Mr. Market is always rational and his quotations are always the true and respected determination of what the companies I own are worth? Are you kidding me? Ever since reading Benjamin Graham I have believed that I should determine my own range of value, and then treat Mr. Market like "some guy" -- some other partner in the business who shows up every day and tells me what he thinks a share is worth and offers to buy my stake or sell me his at that quotation. On Monday morning he had completely lost his mind. Was he forced to sell ARCC at such prices? Was he in a panic? "He" is basically a collection of other owners of the stock -- other partners in the business. Some of those partners may certainly have been in a panic, looking to sell at any price: sell "at market" (click). Some of those partners may be funds who believe in the company but whose investors have pulled their money out of the fund, forcing the selling of positions.

Whatever happened to Mr. Market that morning of Monday, August the 24th, 2015, it was "an event." The overall event and this ARCC case study example in particular which I experienced first-hand, reinforced my way of thinking about how to approach Mr. Market and the quotations "he" regularly presents: sometimes I will find the price he quotes to be an excellent deal and I will want to buy his shares, other times I will find the price to be too expensive and decline his offer (or, sell him some of my shares). But at the end of the day what I own in my portfolio are pieces of businesses, for each of them I am a partner in a company not a partner in a number on the screen. If I still like the company and still want to own my piece of it, I can choose to do so and tell Mr. Market "thanks for the quotation, have a nice day." Paying careful everyday attention to Mr. Market's quotations, paying careful everyday attention to what those quotations spell out for year-to-date, month-to-date, whatever-to-date performance, that is my choice. For those of us here on VF who are individuals and don't need to report our numbers to clients or investors, we have such a luxury of how we decide to let Mr. Market's quotations influence which businesses we own in our portfolios! We have so much freedom -- we don't have to calculate our YTD performance based on what Mr. Market says our positions are worth at this instant in time. Should I care what Mr. Market said my portfolio value was on the morning of Monday, August 24th if I had every intention of holding my current positions for years and years? Should I care what my YTD performance looks like when my real goal is to build wealth for many years out from today? Everybody is going to have their own approach to investing; some would react to their stocks dropping on Monday morning and say "uh oh, my defined -10% (or whatever level) loss threshold has been breached, my rule is to sell" (and maybe some of that behavior played into the insane quotes we saw). I don't see things this way, because I don't believe Mr. Market is always someone to believe, trust, and respect. Over very long periods I have to believe he'll get things close to right... but if I don't trust the guy to give me reasonable quotations over a short period (which I don't), then why on Earth would I let his quotations cause me to sell at a price I believe to be ridiculous? It is almost unthinkable to me that anyone would have reached a rational decision that on the morning of Monday, August 24th, that $11.60 was a reasonable price for ARCC to trade... and yet, there it was, and actually buyable at that price. And now as I type it is at $15.32; within a minuscule time period (not years and years apart), Mr. Market has valued this company at two prices that are 32% apart! A case study among many other examples, of totally irrational pricing by Mr. Market.

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Black Monday Case Study: ARCC