From the February 2005 Break Out Report

Acute vs. Chronic Problems
by Marco den Ouden 

One of the real estate investment strategies used by Raymond Aaron, real estate guru and founder of the Raymond Aaron Monthly Mentor program, is to look for property in disaster areas. For example, when a devastating tornado struck Edmonton a number of years ago, he flew out and bought property in the area most affected at depressed prices. He explained the strategy as one of distinguishing between acute and chronic problems.

An acute problem is one that strikes unexpectedly, is quite severe, but is a one shot deal. The problem happens. It’s over and done with. A tornado striking Edmonton is an unusual event and unlikely to happen again.

A chronic problem is an on-going situation. Property in a flood plain is an example. Regular recurring floods will keep property values depressed.  There’s no point buying property there.

The same thing applies to stock investing. Sometimes companies face a one-time problem that may cost them and affect profitability. But once the problem is resolved, the company continues on as before. If the stock price takes a hit in the face of this problem, it will likely recover once things return to normal.

A prime example of such an acute problem is the quarterly loss announced by Westjet on Tuesday.  It was the first quarterly loss in eight years and it was substantial – a loss of $46 million or 37 cents a share compared to a profit in the same quarter a year earlier of $12.8 million.

Westjet stock had been slipping for about a year because of a chronic problem – an ongoing legal dispute with Air Canada over corporate espionage. In November it finally started recovering as investors realized all the potential bad news from the legal problems have now been factored into the stock price.

Then Tuesday’s announcement and the stock dropped 49 cents, falling further the rest of the week.

But let’s  look  at  the reasons for the loss. Westjet incurred a $47.6 million write-down when it moved to replace its aging fleet of Boeing 737-200s. That accounts for all of the loss. There were also problems with a computerized booking system that created a drag on profits.  Both are acute problems.

In fact, Westjet’s new fleet of next-generation aircraft give the company the most modern, fuel-efficient planes in Canada and will save the company $30 million a year in operating costs. That spells increased long term profitability.  In fact, there is some speculation that rival Jetsgo with its fleet of older planes may go under.

So if a profitable and growing company declares a loss, look to see if it is because of an acute situation.  Or is it because of problems that may continue to plague the company for some time to come? An acute problem just may mean a good buying opportunity has arrived.

Follow Up to the Above Article

No Guts, No Glory!

Only those who dare to fail greatly can ever achieve greatly.

- Robert F. Kennedy

Right now I’m reading Jack Canfield’s new book The Success Princples, one of which is Feel the Fear and Do It Anyway. Canfield writes about how fear can often paralyze us into inaction or inhibit us from taking advantage of an opportunity. A case in point came strikingly home two weeks ago.

Last month I wrote a strategy article on acute versus chronic problems (See Vol. 3, # 8 – page 4). An acute problem is one that strikes quickly, is temporary in nature and goes away. A chronic problem is one that lingers and continues to plague the afflicted business for a long time. As an example, I looked at the recently released quarterly report for Westjet. The company suffered its first quarterly loss in eight years and it was a whopping $46 million. This loss wiped out an entire year’s profits. The stock took a hit, dropping from $12.65 to $12.16. The next few days saw it drop further to $11.70, a total of 7.5% in three days. But, I pointed out, Westjet’s loss was entirely attributable to a write-off of $47.6 million the company incurred as it replaced its aging fleet of Boeing 737-200s.  A blip in its computerized booking system also contributed to the loss.

These problems were acute problems – fleeting in nature. Westjet’s purchase gave it the most advanced fuel efficient planes in Canada and will give it cost savings of $30 million a year going forward.

I also pointed out that rumours were circulating that rival Jetsgo was in trouble and could go under.

In my own account, I had bought 6 contracts of April $11 calls on Westjet when the  stock  was  around  $13. It cost me around $2500.   The  stock   quickly jumped to $14 and I thought all was well with the world. But then it started sinking and the news of the $46 million loss drove it down further.

While my logical brain  inspired the acute versus chronic article, my safety principles had me sell the options at a loss. And indeed, the stock continued to drop, hitting $10.80 on March 1^st. My plan was to wait until the stock showed signs of recovery and then buy back the options. It was the safe play, not the gutsy play.

The gutsy play would have been to buy more options at drastically reduced prices as it dropped.  The $11 calls could have been bought at under a dollar instead of the $2.50 I paid. Or I could have bought calls further out.

Comes March 11^th and Jetsgo declares bankruptcy. Westjet jumps to $15.60. In the next few days it climbed to $16.80. I could have made a small fortune. Instead I took a loss. I sure wish I’d read Canfield a month earlier. Maybe it would have given me the guts to reap the glory of fantastic profits in Westjet!!! Further gains lie ahead as Westjet picks up Jetsgo customers and raises prices.

Afterword: As it turned out, that quarter was only the first in four showing a loss for Westjet. The stock peaked just above $17 and then fell steadily for the next year and a half to below $10. It recovered to $13.50 by January 2006 then fell again to below $10 forming what is sometimes called a double bottom in August 2006. Since then the stock has been on a tear as profits improved and have proved sustainable. It is now approaching $17 again.

Disclaimer