One of the hardest psychological biases for investors to overcome is anchoring. I know that first hand, as after 25 years of investing I still haven’t completely conquered it.
Anchoring causes investors to both miss great opportunities, as they think the price has run too far, and to take profits too soon. It’s at the root of some stupidly popular philosophies such as ‘playing with house money’ — e.g. selling half of an investment when it has doubled.
I mention this now as I want you to be aware that there is a possibility my recommendation to lock in some profits on Maverick Drilling & Exploration (ASX: MAD) is biased by my own anchoring.
Where be those anchors?
I first recommended Maverick back in early August 2011 when shares were swapping hands in the mid to low twenty cent range. The share price remained around that level until mid-January when Maverick upgraded its reserves – for a second time since listing.
With the shares then at 28 cents I again recommended the company and said, “Despite the price rise, Maverick presents a compelling risk reward picture, with limited downside and excellent market trouncing upside potential.”
In February, internally at least, I recommended we make Maverick our next official Share Advisor pick. After spirited debate, the Share Advisor team agreed, despite the price having run up to 48 cents. We clearly conquered our anchoring that time!
As you’re aware Maverick did not make the starting line-up that month. With a week to publication the price had climbed to over 80 cents and we made the decision that Maverick no longer had an attractive risk to reward profile. In short we thought it was close to fairly valued at 80 cents.
That was then this is now
That’s all history now, so let’s take a look at where we are today.
It’s our view that Maverick’s share price has become completely divorced from the underlying future cash flows of the business. In short the share price is being fuelled by investor greed rather than business fundamentals.
All shares are ultimately worth the present value of the company’s future cash flows. The only way to justify a half billion valuation for Maverick is to assume some very optimistic future cash flows. Therein lays the problem. If everything needs to go right to justify the current price, then the real danger is to the downside.
Cash flows aside, the following chart illustrates that Maverick is no longer a bargain based on 1P reserves. The price per barrel of 1P reserves that investors are paying for Maverick has shot up from $3.70 in January to around $19 today.
On a 2P basis the valuation has gone from a ludicrously low $1.40 per barrel to be now around $7.
Yes, both of those reserve valuations are likely to drop — perhaps substantially so — when Maverick releases initial reserve estimates for Nash Dome (possibly next week) and then again in a couple months when it releases Boling Dome reserves. And yes, neither valuation is expensive in its own right. But there is more to valuing an oil company than reserves.
Despite our bullish outlook on reserves, Maverick’s price will ultimately be based on its potential cash flows. And that’s where we’re not so bullish.
Investors seemed to have brushed aside the disappointing first quarter 2012 production figures. Maverick produced 764 BOPD (Barrels of Oil Per Day) in December 2011, but only 757 BOPD for the January to March 2012 quarter. For the last three quarters, production has only grown at around 3.5 percent quarter on quarter.
Yet speculation is rampant that Maverick will do 1,500 BOPD by mid-year and 2,000 BOPD by the end of 2012. To achieve that half year target Maverick would need to double their production this quarter. To achieve the end of 2012 target it must grow production at 40% quarter on quarter for the next three quarters.
Remember Maverick has only grown production at 3.5 percent per quarter for the last three quarters. Also, please note, Maverick are not claiming those production targets.
It’s also true that there were good reasons why production slipped in the recent quarter, compared to the December figure and the earlier announced 900 BOPD flow rates. But there are always good reasons why production will not increase in a straight line. Production figures should not be extrapolated based on high points in flow rate, or on the current drilling success rate. It’s important to always view your investments and valuations through a conservative lens.
Maverick has purchased two new rigs, but it will take until our spring time before they can be productively used.
Foolish Bottom Line
Increases in reserves, production and acreage are all highly probable throughout 2012, perhaps starting as soon as next week. So yes, by recommending investors take part profits it does feel like I’m stepping in front of a fast moving freight train!
Maverick has a lot of potential, however the share price has run ahead of that potential. We conclude that at around $1.30 it would be prudent to take at least part profits.
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One of the hardest psychological biases for investors to overcome is anchoring. I know that first hand, as after 25 years of investing I still haven?t completely conquered it.
Anchoring causes investors to both miss great opportunities, as they think the price has run too far, and to take profits too soon. It?s at the root of some stupidly popular philosophies such as ?playing with house money? ? e.g. selling half of an investment when it has doubled.
I mention this now as I want you to be aware that there is a possibility my recommendation to lock in some profits…