When looking for investment opportunities, we prefer bullish opportunities to bearish ones. If we were to describe our ideal investment it would have a number of characteristics, which are listed below.
- A stock of a company that has broken a flat to bearish trend for that had been going on for the previous few years
- A company would continue to grow revenues and income.
- Valuation metrics are about half the level of the median stock in the S&P500, Russell 2000 or some other broad market index.
- A company that services an important element of the economy, such as food, healthcare, transportation, financial services, consumer products, education, entertainment, etc.
- A company that has a multi-billion dollar market cap, but one that is not an exciting “story” stock.
- A company that is unfairly suffering in the financial press, by pundits on popular TV shows, and/or analysts.
- A company with modest amount of debt
- A company with modest CapEx requirements, so that company can still grow with modest investments while enabling the company to pay a dividend for income investors and repurchase shares for capital gains investors (not to mention that buybacks help support the share price).
A good example of this kind of stock is Discovery Communications. It broke a downtrend, started a new uptrend, has very attractive valuation metrics (P/E = 14, EV/EBITDA = 9.7, PEG 1.2), and the technical indicators of MACD and RSI suggest the slow uptrend should continue. Furthermore, the company bought back close to 10% of their stock per year over the last few years.
As a result of our expectation, the stock will grind slowly higher, so we suggested investors consider selling a cash covered put on the company’s shares. Click here to see the original article we wrote on January 30, 2017. After a huge run-up in share prices, we are having difficulty finding bullish situations that meet our disciplined criteria. Consider the following.
Notice that the median stock in the S&P 500 trades at a PE multiple of 21.5, while the median stock that shows up in our proprietary opportunity finder is a lofty 23.4. The other ratios are elevated as well.
A closer look at names that meet some but not all our criteria have price charts that look like they want to top out at anytime. Take Royal Caribbean Cruises. It has had a nice run since the election and still trades at a reasonable PE multiple of 16.5, which is a 22% discount the median stock in the S&P 500. But a review of the technicals, suggest that the share price is about to roll over. We are seeing this pattern over and over, which is a warning sign for the individual stock and potential the market as a whole.
We need a number of our criteria to line up to participate in a low-risk endeavor. If they do not, we must be disciplined and wait for the stars to align. As a final note, equities that are breaking down are stocks that look cheap from a valuation perspective. In the final analysis, we think price action and valuation are out of sync. We might go so far as to say they are upside down. The data below shows the valuation metrics of stocks that are vulnerable to a selloff. Notice that the valuations are less then the typical stock.
With the potential for a selloff in the overall equity markets that could last from a few weeks to a few month, we continue to look for expensive stocks that are in the process of rolling over. Until we find opportunities that fit this bill, we will be patient. But we think we are getting close.
