This is part two of my responses to some of the emails, messages, and tweets I’ve received in recent weeks. Part one was posted on Monday.
A number have readers have contacted me wondering about specific stocks. I generally don’t like to comment on companies I haven’t studied, so I have been reluctant to offer my thoughts on most of them. However, I thought it might be worthwhile to respond to this tweet from Thomas Yarbrough (@tmyrbrgh):
Once again, I’d like to thank everyone who has emailed, messaged, or tweeted at me since my book Dead Companies Walking came out. I’ve tried to reply directly to as many folks as possible but running my fund has taken up most of my time and attention, so I thought I would post my responses to a few interesting questions, comments, and criticisms I’ve received in recent weeks here. Unfortunately, I couldn’t fit everything into one post, so I had to break my responses up into two parts. I’ll post the second half on Wednesday.
First up, an email from a reader named Greg:
“I am a private investor who has been investing on the long side for most of my career. I’ve almost finished your excellent book, ‘Dead Companies Walking,’ and it has inspired me to start trading the short side as well. My immediate question is: Where do you find all the good ideas? It’s fairly easy to find long ideas in places like Value Investor’s Club (of which I am a member), or the published portfolio lists of hedge fund managers. But where do you get quality short ideas? Thanks for your help with this!”
In theory, Wall Street analysts are paid to predict the future earnings of the companies they cover and use those predictions as the basis for their stock recommendations. In reality, this is not always how the game works. Often, analysts seem to forget that earnings and earnings growth have always been the mother’s milk of stock prices over the long term. Instead, they focus on short term price fluctuations, lowering ratings when a company’s stock drops, even as its earnings estimates rise.
Make no mistake, as I’ve repeatedly warned, most stocks making the 52-week low list are there for good reason. The large majority of them are heading lower, and many will cease to exist. Conversely, most stocks making 52-week highs are likely headed higher. However, profitable exceptions to these rules do exist. With a little digging, investors can exploit the imbalance between the Street’s short-term perception of a company, as reflected in its stock price, and its long-term prospects, as reflected by its earnings outlook.
Two high profile commodity companies filed for bankruptcy last week. The first was St. Louis-based coal producer Peabody Energy (BTU). Peabody was the latest coal producer to file, following Arch Coal, Alpha Natural Resources, Patriot Coal, and Walter Energy. BTU quickly fell below $1 on the news. Just a few years ago, Peabody’s market capitalization exceeded $20 billion. On Wednesday, Houston offshore oil producer Energy XXI (EXXI) joined Peabody in bankruptcy court. Four years ago, EXXI was a $32 stock. On Thursday, the day after it announced its bankruptcy filing, it closed at 12 cents.
I have lived in Marin County, possibly America’s preeminent left wing enclave, for over two decades. Marin residents are old (and getting older), white, and vote heavily Democratic. They overwhelmingly embrace abortion rights, drug rights, and gay rights. Church attendance is extremely low; mind-altering pharmaceutical drug use and therapist attendance is extremely high. The cult of self is Marin’s dominant religion. And outside of Greenwich, Connecticut there are probably more money managers, per capita, in Marin than anywhere else in America. Marin’s attitudes are not unique. The investment community and the media/cultural elites on both coasts share a suspicion (or dislike?) of religious, socially conservative Americans. That might explain why companies that cater to the values of Red State residents are poorly understood, poorly followed, and often undervalued by the stock market. Continue reading →
Before I get to this week’s post, three quick notes:
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Thanks to everyone who has bought the book recently and commented on it online or by writing in to me directly. I’ve been extremely busy lately running my fund, so it’s been difficult for me to respond to email messages and/or comments on my articles, but I am hoping to write a post soon addressing some of the questions I have received.
Okay, on to this week’s post …
Study after study has shown that most individual investors underperform the indexes. Why? They neglect a few simple rules. The first, as I have repeatedly warned, is never to buy a stock below $5. These junkyard stocks are usually over, not undervalued, and most are heading to oblivion. The second rule is to avoid excessively valued stocks in “cult” industries. Today, social media stocks fit this description, as do Tesla and many companies in the renewable energy space.
So, where should an investor place his or her chips? One place to look is companies paying meaningful (but not excessive) dividends. Historically, those stocks have outperformed the indexes. A second winning strategy is to identify companies that generate big cash flows but trade at low multiples of earnings. I recently traveled to Reno, Nevada to meet with the managements of two regional gaming companies that fall into that category: Eldorado Resorts (ERI) and Monarch Casino (MCRI). I purchased shares in both companies shortly after those meetings.
Ever since oil cratered to $26/barrel on February 11th, prices have steadily inched higher. West Texas Intermediate has now climbed into the $40/barrel range. Not surprisingly, energy stocks have kept pace, with many service companies and independent producers hitting year-to-date highs. Unfortunately for some energy firms, however, this recovery will probably be too little, too late.
Shake Shack, like GoPro and Fitbit, was once a high-flying, wildly valued cult stock whose shareholders loved the company’s products. Yesterday, that affair ended abruptly, with SHAK falling $5 to $37 on disappointing guidance for 2016. The former fast casual darling is now down 60 percent from its $97 peak last May. Investors who look at price, and not valuations, might think this is a good entry point.
Last week, USA Today reported that an unbelievable 359 stocks on major exchanges are now below one dollar, up from 222 just two months ago. To put that number in perspective, twenty years ago only 60 stocks on major exchanges were “hat sized,” or trading for fractions of a buck. At the end of 2008, during the worst depths of the financial crisis, there were only 242 sub-$1 stocks:
A few months ago, I wrote about strong insider buying and how it can be a promising sign for a company’s future stock performance. Last week, JPMorgan Chase’s CEO Jamie Dimon paid $26.6M for 500,000 of the company’s shares at $53/share. That’s about as strong as insider buying gets. The news immediately boosted the bank’s stock. It closed yesterday at $58, though it is still down 12 percent YTD versus a 6 percent decline for the S&P 500 and a 16 percent decline for the S&P 500 banking sector (KBE).
To his credit, Dimon has consistently bought large amounts of his company’s stock over the years, and his investments have always turned out well for him. Many analysts believe his latest purchase could signal a bottom for the financial sector. Does that mean investors should follow Dimon into JPM and other bank stocks?