SLOW, DRIFT AND DOWN

Morning Thoughts:

HRAY will be under pressure this morning, and it probably will test its low of $7.5. I believe the worst thing to do would be panic and sell it at new lows. The stock is supported by its relatively low valuation and potential buyback. You just have to endure the near term pain a bit. Despite the relatively large position, it still accounts for less than 4% of my total portfolio, and therefore, its impact will remain limited and could easily be absorbed. There is no sense to panic. We are talking about a company that makes a lot of money, cash flow positive, clean balance sheet with a lot of cash.

MRGE also appears under pressure this morning. For a speculative position such as this one, you got to take profits when you can, even if the profit is very small. For all the mistakes, I still have a hard time to take the tiny profits. Remember, a lot of trades are break-even trades. The key is managing the downside risk, and the upside will take care of itself. Having said that, I do not believe I should be panic here either. I continue to believe the risk/reward is favorable here and downside risk is limited.

Mid-Day Reflection

The market is a sea of red, and GOOG is not helping at all. While my portfolio will be hit pretty hard today, it is somewhat expected, given the strong run recently. I thought a dip is due. Also, the decline of HRAY and MRGE is modest, much less than I expected. I even nibbled up a little trust (ATS.UN) for lunch. The company has a very strong nitch and its revenues and EBITDA growth has been impressive. Margin has been contracting in the last few years, however, the fuel costs could decline somewhat this year, which will help its margin. This is a very small trust and there is not a lot of coverage. I am looking for a 20% return (10% appreciation and 10% yield).

BASIC INSTINCT

HRAY

LTON's results were terrible. I am starting to have some concerns about HRAY, which reports tonight. Maybe I should peel some today if it moves up to reduce exposure. I am not too concerned about the upside, it is the downside that I am concerned. I put a limited order to sell half of HRAY at $8.50. That would have been a good trade, unfortunately, the order was not filled. HRAY's results were bad, worse than I expected. My instinct was correct, again execution was terrible. Those limited order costed me a lot of money. I should have sold at market.

Now the question is: what to do with HRAY. Clearly the company failed to grow, margin is contracting, competition is fierce. While the valuation remains compelling, I believe there are two fatal weaknesses: fierce competitive pressure and lack of pricing power. Although HRAY is doing a good job of expanding its businesses, these strategic initiatives will not be fruitful for a few years. In the meantime, we have to deal with the slow growth, contracting margin and reducing earning power. While I am incline to sell this stock, tomorrow probably is not the good time, particularly at opening. Having said that, I believe I probably should peel some tomorrow and leave a small position to close in the future.

MRGE

I think I should take profit on this one as it was a speculative trade and it worked out alright. Do not be too greedy. Same for MRGE. I put a limited order and did not get filled. This one I should close the position as soon as possible as I do not see any catalyst in near term.

DEFERRED OR DESTROYED

MRGE

MRGE fell by $5.0 this morning, good for almost 20%, because a piece of announcement where revenues from a couple of large contracts have been deferred, and it has delayed its release of its Q4 and 05 results. Obvious the market is extremely nervous, particularly with respect to accounting issues. The question is: does this revenue recognition issue warrant a 20% haircut? The company reiterates that there are no fundamental changes of its business, strategically or operationally, cash from the deferred revenues is collected, and deferred revenues will be recognized in subsequent quarters. The company maintains its long term growth targets.

I opened a small position on MRGE ($19.75) because it appears to me that there is a lot of "shoot first, ask question later" types this morning. I also suspect that a lot of institutions belong to the group of "accounting irregularities, run" category. There might also be some wondering of "the theory of cockroaches". The haircut makes the valuation compelling here. At $20, it is traded at 11X of its 2006 EPS, granted, the $1.8/share number will likely be reduced. More important question is that: is there another shoe to drop? Is this a honest mistake or a real accounting shenanigan? I am giving the management the benefit of doubt here. This definitely is a much more speculative purchase, and I have to keep an eye on it.

Exit Strategy: there are two here, one is to sell it anywhere above $20 level, alternatively, to sell some calls when it recovers somewhat. If writing cover call is elected, I believe I would prefer the short tenue ones (no later than June).

PLAY OF THE DAY

MT.TO

MT announced its Q4 and 05 results this morning. The stock closed at 13.60 yesterday and opened at the same level, indicating lack of confidence on its numbers. At the first glance, I thought the results were pretty good and the stock seems to be a buy at this level. However, I got a couple of questions, and I decided to wait for the conference call. Big mistake, the stock opened at $13.50 and went up to $15.5, that's a 15% gain on the first half of hour of the day!

I still believe this is a good company and the stock is still a buy at this level. Growth: revenue: 31%, EBITDA: 39%. EPS is not a good number to compare as it was diluted due to this year's IPO. Profitability: gross profit margin: 61%, EBITDA margin: 24%. ROE: 19.5%. Balance sheet: no debt, large cash ($2.0/share). It is in the right space as delivery of TV is in a generational type change to HD. IPTV is another growth driver. The HD equipment market is growing at about 10% annually and I believe that rate will accelerate in the next couple of years. MT is also taking market share from other providers. There are also some near term catalysts such as World Cups, and Olympics in 2008. The company is also looking for acquisitions, mostly to acquire technology and also accretive. Valuation is reasonable. It is traded at 18X of EPS05. While the company does not provide forward guidance, I believe it is not unreasonable to see 0.95-1.0 per share for 06, which will lead to 15X of earnings. This is rather reasonable in view of its 30% topline and EBITDA growth.

I like to open a small position, preferably below $15. While this is no longer a "buy low, sell high", it probably is a "buy high, sell higher".

CRIME AND PUNISHMENT

CNQ/TLM

I closed positions this morning with a loss, a fitting punishment for my stupidity. This is third time that I tried to make some speculative quick money and I failed all three. I am truly not very good at this short term trading game and and I MUST stop. Desire for quick money often leads to losses. You got to be patient and wait for the opportunity to come to you.

MTK

It has down by 20% over the past two days for no apparent reasons other than the fact that its CFO has decided to leave for personal reasons. This is a very thinly traded stock and it tends to swing widely. The company also reiterated its FY06 guidance. While the recent senior management changes were not exactly positive signs, I believe the punishment seems to be unwarranted. I added some (4.6) here and I believe it will bounce back to 5.5-6.0 range for a 20% gain.

BLKB

BLKB also down significant since yesterday. The decline appears caused by a small piece of news that one of its major shareholders have decided to distribute its holdings of BLKB to its investors, who may or may not elect to sell them. Again, I thought the fall is unwarranted. I was tempted to open a position at 18, however, I thought the upside is not sufficient for me. At 17, it becomes more attractive to me. I believe it will reach 20 by the end of year for a 17.6% gain, plus dividend. More importantly, I believe the downside risk is limited.

AXC/CVI

Continued with winding down of my energy positions. Sold both ASC and CVI. I believe both are good companies and have potential. However there will be a correction in crude price in the next few months and I can buy them back with lower pricing.

BDT

Closed the small position of BDT (46.5) here. The trust is priced at $12/units, which implies BDT's pricing of $44.35 ($12*3+8.35). If my understanding is correct, BDT's share should be moving towards $44.35 in the next few days, until effective date, which is scheduled on Feb. 27. Given, that better to trust my understanding and take profit here. In any event, 21% return for about one months is not too bad at all.

LESSONS LEARNT

CNQ/TLM

I opened large positions in two large cap energy stocks (CNQ/TLM), unfortunately, both went down after opening. I am very upset with myself and I have to come here to try to calm myself down. Let's see how many mistakes made here. First of all, I am too anxious to make some quick money and it is never a good thing. It is emotional and it really affects (negatively I may add) my judgment. Secondly, never buy from opening. In fact, never buy in the first half hour. Wait to see where the market going before committing. Third, I should have opened a small position and add on when it weakens. Fourth, always ask youself, are you "buying low, or sell high". I do not believe I was this morning.

Having said that, the worse mistake I could do is to panic and dump them here. Both are quality names, and oil appears reversing itself and moving upward. The volume is small and moderate, indicating some profit taking. I believe the crude will continue to move up from here to mid-60s and energy stocks should perform well. DO NOT PANIC.

AST

Adding some AST here (16.50). This is a simple trade. The spin-off will be the near term catalyst to boost this one to lower 20s.

CNTF

Adding some CNTF (13.25) here. It was down by 16% today without any news. There will not be an earning miss as the company has reiterated its earnings for Q4/05 and 2005. At this level, the valuation is becoming compelling again (about 13X of EPS06). It appears that the selling was a bit of over-done, and there's some panic in the air. I expect it to bounce back to 14-15 level in the next few days.

MICRO CAP GEM

MLAB

It turns out a pretty boring day and I spent some time to look into some small stocks. MLAB is another company similar to UTMD, a sleeper and a microcap. Nonetheless, I really like this little company because (1) consistency, the company has been consistently making money for the past ten years, despite a rather severe recession in 2001-2002; (2) steady and decent revenue and earning growth (about 10%); (3) margin is improving steadily; (4) very significant management ownership (about 25%); (5) strong balance sheet with large cash position ($3.3/sh), no debt; (6) a decent level of dividends (1.9% yield); (7) stock buyback; (8) decent return on equity (15%) and on capital (29%); For the purpose of assessing this company, ROC is a more appropriate measurement as its balance sheet is severely underleveraged. (9) valuation is reasonable. It is currently traded at 17X of its FY06 (March/06) EPS estimate (0.85); However, if we take the cash out, it is traded at 14X, definitely at a discount to S&P and its peers. Assuming a decent growth in FY07 (0.93), it is traded only 13X of its FY07 EPS. I believe it should be traded at 20X, which will put it at 21.5. My one year target is 20, representing 33.3% return.

The obvious drawback is that it is a micro cap with only 3 million shares outstanding and the company continues to buy them back.

TAKEN OUT BY TAKE-OVER

VFC

VFC was taken out by TD this morning at 19.50. Needless to say that I am rather satisfied and more than happy to submit my shares. I also tool some half of ISC's profit off the table. I believe the near term out look for energy and drillers remain downward and I did not like the announcement from ECA that its capex will be cut. I suspect that more producers will announce similar cuts in the next few months. This does not bode well for drillers. Although the drillers tend to lag for about six months or a year so, better be early than late. I would like to continue to cut my energy and driller holdings.

I also add some FMD.UN. I like this little trust because (1) it is in the health care industry, a stable and growing one; (2) recurring business; (3) relatively little competition; (4) decent valuation; (5) modest growth (5%-10%) going forward; (6) decent yield (9.%).

I would also add more ATS, although I would like to buy them at 16 level. I believe I still have some time and I do not have to rush.

SHOT THE HIGH-FLYERS

CUTR

CUTR has a good quarter, but the guidance for Q1/06 is slightly conservative, particularly in the revenue growth. The stock is down by about 10% in the pre-market (26.75). This might be a bit over done. There potentially is some panic selling this morning. At 26.75, valuation is becoming reasonable by itself (in view of its strong growth) and extremely cheap compared to its peers, although the theme of this quarter has been “shot the high-flyers�. There is a reasonable chance that it will make the low of the day and bounce. The near term tone of the overall market might help as well. However, this is not a stock to “buy and hold� as the risk of potential litigation is simply too great. Moreover, the whole sector is losing steam and I expect the multiple will continue to contract.

STP

STP is also down by about 10% this morning. This one is more difficult to see, mostly because it is very expensive (about 70-80 times of its 06 earnings). However, this is a favorite of the momentum and it is the fad of the moment. My gut felling is that it will decline a bit further from here simply because there is quite a bit of profit out there and I assume momentum players would want to take it before it vanishes. It is also consistent with the theme of the quarter, i.e. “shot the high-flyers�. Having said that, I probably would not want to pick a fight with dip buyers.

DYNAMICS RESEARCH

DRCO

- Small cap ($125 million market cap);
- Valuation reasonable (11.3X of its 05EPS), not compelling though;
- Modest earning growth (10%-15%);
- Meaningful improvement of margins;
- Reasonable level of ROE (17% in 05);
- Manageable balance sheet;
- A number of contracts awards announced recently;
- Q4/05 seems in the bag;
- Management appears to be experienced and strong;


- Dependency on the defense industry (political uncertainty in the next few years);
- The stock seems to struggle and trending downward;

HURRAY

HRAY

Average down a bit here (7.75). The one time charge of 0.7 million account for approximately 0.03 of its pending Q4/05 EPS. It was also pulled down by the warning of LTON. HRAY has not lowered its Q4/05 results other than the charge and it is still extremely cheap. At this level, it is traded less than 10X of its 05EPS and it is still growing. Valuation is compelling and it is hard to find a comparible company in the US market.

OFF THE TABLE

CUX / COM

I sold my small position of CUX yesterday and took some profit of COM. I planned to sell CUX here in order to raise some fund.

SMTS announced yesterday morning. While Q4/05 was alright (which was expected), the 06 guidance is weak. Moreover, it announced that it will offer approximately 2.45 million shares. The combination of weak guidance and more shares spook the market and it went down by more than 15% in two days. This is the problem of purchasing high multiple stocks. Earnings and forward guidance have to be perfect, or else. I thought the guidance is conservative and the management did a poor job to elaborate the use of the fund, and the adjusted EPS for 06 so that an apple-to-apple comparison can be made. If this is a case of under-promise / over-deliver, the management better deliver, because at the current guidance, its valuation is rather expensive.

I decide to keep it for now and wait for Q1/06 results. I continue to like it because of (1) monopoly; (2) pricing power; (3) relatively lower penetration ratio; (4) subscriber type of revenue stream; (5) clean balance sheet; (6) international opportunities; (7) potential take-over target. But this one could cause me some sleep in the next few months.