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  2006 in review — U.S. stocks

BENJ GALLANDER and BEN STADELMANN

Friday, January 12, 2007

In our last column, we reviewed Canadian stocks that were featured over the past year. Here is a reality check on those from south of the border.

In a recent article on forestry, we talked about how that sector seems to be in as bad a shape as airlines were in 2002. Our February airline column, which featured Air France American depositary receipts, then trading at $24 (U.S.), also made the point that a heavyweight with low expectations in a beleaguered arena is apt to outperform those corporations judged to be the class of the field — in this example, Southwest Airlines and WestJet.

That was then, but how about now? Southwest is stuck in a holding pattern: then trading at $16.42, it's now $16.15 for a small loss. WestJet has done much better, climbing from $10.89 to $14.60 for a tidy 34 percent gain. But Air France has trounced its youthful rivals, currently flying at $44.65, for a blazing 86 percent increase.

Also last February, we looked in on the U.S. funeral business. Service Corp. International was trading at $8, much improved from where it used to be, but still in the process of shaking off legal troubles. Competitor Stewart Enterprises which we also own, was trading at $5.12 and recovering from damage inflicted by Hurricane Katrina on its operations in the southern United States.

Since then, Stewart has clawed its way back up to $6.38, but Service has been the big surprise, buying out Alderwoods for $856 million. This has made us a bit nervous, as Service got into a heap of trouble a few years ago by expanding too fast and taking on too much debt. However, given that competition in this field has diminished over the years, this move will likely improve margins. Investors have been upbeat, sending the stock up to a lively $10.68. It still has a way to go, though, to hit our target of $13.84.

In April, we examined Sea Containers, a favourite holding of value investor Irwin Michael of ABC funds. Though we have tremendous respect for Mr. Michael, and agree with his point about buying assets at a large discount to book value, we had grave doubts about this one. Instead of turning around, the company appeared to be sinking fast. In fact, one of us tried to short it at $6.50, but was unable to borrow shares. That s a shame because, as anticipated, the debtholders torpedoed the corporation, forcing it into bankruptcy. It now trading on the pink sheets at $1.30 a share.

We all make mistakes. In fact, in May we hung out one of our own boneheaded moves, our investment in MRI manufacturer Fonar. Though the stock had crashed to 26 cents from our purchase price of $1.25, we stuck with it because the chief executive had just bought shares at 55 cents, and management told a sweet story about the stock getting back over a buck by year end. No dice. We finally pulled the plug and took the tax loss at 30 cents, not far from its current trading price of 28 cents.

Though we were early in calling a top in real estate, in June we gamely talked about it again, looking in particular at a couple of outfits that seemed vulnerable in our assessment, yet had garnered enormous interest from U.S. hedge funds. "Did these big players know something about the real estate cycle that had eluded us?" we asked ourselves.

Mall developer Mills Corp, then going for $28.65, was up for sale. No buyer was found, and this week Mills admitted that bankruptcy might be the only way out of its debt burden, sending the shares to $15.23. Frankly, we're amazed the fall hasn't been more severe, and reckon it is still a good short candidate, though obviously the timing could have been better earlier.

Finally, last summer we revisited Network Equipment, wondering if it was ready to put in a double bottom. After riding it from $3.65 to $11.74, where we sold three-quarters of our position, we held the remainder of our position right back down again. Though we considered buying more shares at its then trading price of $3.24, we were cautious and suggested that we needed to see another solid quarter of data before becoming convinced.

Those encouraging signs did show up in October, but by then the price had rallied to $5.03. By our own logic, it would have been a good buy at that point, but due to lethargy and our allergy to averaging up, we didn't. Ugh! The stock is now trading at $7.77. Oh well, we still have our shares, but we could have played this one a lot smarter.

Back in the real world, here are our actual results for the Contra portfolio for 2006. The return was 9.1 percent, not bad on an absolute basis, but the market indexes were nicely ahead. Our five-year annualized return now stands at 29.0 percent and the 10-year number is 23.4 percent.


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