When I use the term “optionality”, I’m referring to a situation where binary outcomes are possible and it’s difficult to determine the likelihood of either scenario occurring. When it’s difficult to determine something, the market will sometimes take the lazy route and just ignore it. That’s where the inefficiency comes in. Bill Miller has said the market won’t pay for optionality. In my experience, this is often true.

One such situation is occurring now with Carrizo Oil & Gas, in which my fund invests. Based in Houston, Carrizo is an exploration and production (E&P) company with natural gas reserves in the Barnett shale in Texas and onshore Gulf of Mexico coastline, coal bed methane deposits in the western US and a recent oil discovery in the North Sea.

The company’s current enterprise value is approximately $1.4bn. To get a fair value for Carrizo’s shares at, or below, the market price of $43 a share, you have to ignore a lot of optionality. I come to this opinion based on the following sum-of-the-parts valuation.

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