Pieter [writing last week]: “Calton (CN) is up 48% today! What happened? Yes, I’m still holding on to this (thanks for the tip). Is there still a lot of upside here, or is it time to cash in on this sudden spike?”

I don’t know what happened. There may be upside, but I am cashing in. Here’s the background:

As you know, I’m more prone to provide recipes in this space than stock tips. (Cooking Like a Guy™ Recipe #3 is almost ready. I call it: “Salad.”) But two summers ago, I couldn’t resist. With I-hope-appropriate caveats, I told you about Calton Homes. The stock was then 50 cents. It was $2.75 yesterday. So far as I know, it is NOT something to buy here. But the story illustrates that the stock market may NOT always be rational, and how, in spotting pockets of irrationality, the rational – and patient – investor may find opportunity.

Just as it did not seem rational to me a couple of weeks ago that Yahoo! was valued at more than Ford, GM, Dow Jones and the New York Times Company, combined (so I shorted some), so it did not seem rational to me a year and a half ago that CN would be valued at less than the cost of a used corporate jet (so I bought some).

CN was selling for about 50 cents a share, down from much higher; there were 28-or-so million shares outstanding; and the company’s founder had returned, after retiring, to see if he could rescue it. My thinking was that he had managed to build the company once, and that he had 11 million reasons to try to rebuild it (because his family owned 11 million shares).

So that was possible irrationality #1.

Shortly after my writing about it here, it was announced that a large company would assume all CN’s liabilities and buy all its assets for $48 million — about $1.70 a share. Calton would be left with three employees, an American Stock Exchange listing, $48 million in cash, and a four-year “consulting contract” of $1.3 million a year — enough to pay all the remaining shell’s expenses.

I assumed the stock price would jump pretty close to $1.70 – maybe even go a tiny bit higher – but it quickly settled in at around $1. So you could, effectively, buy $1.70 in cash (well, near-cash) for $1. Not bad!

So that was possible irrationality #2. Indeed, barring something pretty bizarre, this seemed to be all but a “gimme.” Even though I already had a lot of shares, I bought some more. So did some of you. So did the guy with the 11 million shares.

The company announced it would use some of its cash horde to buy in stock below book value. That would make the remaining shares more valuable. (To illustrate: say the company managed to buy in half the shares using a third of its cash. Result: Two-thirds of the cash would remain to be divided over half as many shares. Bravo!)

At the same time, it said that it would explore other businesses to invest in. (Uh, oh! What if they do something dumb with all that money?) But that if it didn’t find something else to do with it, it would distrubute the cash to us shareholders within 18 months.

Today, about 12 of those 18 months have passed. The company has bought in some stock and has made a small Internet investment, which is now branded as eCalton.

Will the company burn through its cash hoard and wind up worthless? Perhaps, but as I say, the founder and his wife have 11 million reasons not to screw it up (13.5 million, actually, now that they’ve bought more shares).

So what happened last week? Who was buying millions of shares? And taking the price as high as 2 7/8? The company says it has no idea.

It’s possible the stock will zoom from here, simply because speculators may notice the volume and the stock’s big move and “like the chart” and like the very low p/e ratio, and – not having any idea what the company does, just that it has a lot of cash, no debt, and a small “dot.com” component – take a flier on it. This would be irrational, in my view – but when has that ever stopped a stock from rising in this market?

Or it’s possible that in a few months the company will distribute its cash and close it doors, leaving the people who paid $2.75 a share with a modest loss.

Or perhaps Calton will allow itself to be acquired for a modest premium to today’s price by some company that wants to “go public” the easy way – by acquiring an already-public company.

Anyway, I would not be amazed to see the stock go higher – and I naturally hope it does, because I still own a lot – but, based on what little I know, I’ve already begun selling.

Tomorrow: Why, Overpriced As I Think It Is, You Should NOT Short Yahoo



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