Like a perfect golf swing, successful value investing seems so simple yet it eludes so many of us. Most investors love the idea of buying a dollar for fifty cents, so why is it so hard to do? Well, like a perfect golf swing, to spot true value you just need to adopt a few tips.
Here’s an important tip (along with some stock picks) that will help keep your value swing profitable: Understanding panic, negativity and cycles is the key to a great opening drive.
“Rule number one: most things will prove to be cyclical. Rule number two: some of the greatest opportunities for gain and loss come when people forget rule number one.”
-Howard Marks
The very best value gains are born from unjustly emotional (negative) sentiment about a stock or sector. Having a trained eye–not blind faith—for when this sentiment attacks a truly great company is the key to finding real value.
The cycle of negative sentiment usually works like this:
1). Media/analyst depression. This comes from one of the following: a). a fantastic stocks growth plateaus or b). panicky headlines swamp an otherwise great company.
2). The market starts to write a story. Example: “XYZ catalyst has happened so ABC great company must be near death.”
3). The market overshoots the mark. Real risks are largely over-exaggerated based on opinions.
Two or three quarters pass…
4). The market takes a Xanax. Risk is re-calculated. Sentiment goes from free-fall negativity to stabilization.
5). The intrinsic value of the company acts like a magnet and pulls the stock price back up.
The exact same cycle occurs with overly positive sentiment and “bubbles.”
So here’s a tip: finding value is as simple as finding profitable companies at about “stage three.”
What companies does the market misunderstand right now? Here are three stocks arriving at stage three:
Coach, Inc. (NYSE:COH) and Apple, Inc. (NASDAQ:AAPL)
Coach, Inc. (NYSE:COH) and Apple, Inc. (NASDAQ:AAPL) are both experiencing the same phenomena right now.
Coach, Inc. (NYSE:COH) is coming off of a year that saw record earnings, wonderful growth in earnings per share, and a staggering return on equity (over 50%). Apple, Inc. (NASDAQ:AAPL)’s last quarter saw 18% growth in revenue, 7% growth in earnings, and cash reserves on their way to a staggering $160 billion.
There is competition though. Coach, Inc. (NYSE:COH) isn’t growing as quickly as newcomer Michael Kors Holdings Ltd (NYSE:KORS), and Apple is fending off advances from the Samsung and Google “tag-team.” So it’s only natural that the S&P 500 has lapped them both, right?
My opinion: record performance + depressed market sentiment= $$$!
These stocks are experiencing the same negative sentiment right now–they’re not “next.”
Because Coach’s story isn’t “new,” the market will focus on negatives like Coach’s exposure to European business while ignoring the fact that the company is growing over 50% in key growth areas (Men’s bags/accessories, china, etc).
Is Kors that different than Coach, Inc. (NYSE:COH)? Even if Kors hits its lofty expectations over the next two years (EPS of $1.86 and $2.45) something as simple as “weak guidance” will cause that lofty valuation to slip. Coach would benefit greatly if Kors returns to earth, and Coach also has a catalyst in new management. The positive sentiment is due to return to Coach.
Likewise, the market (at some point) will turn positive on Apple, Inc. (NASDAQ:AAPL). Tech investors love “new” things. Apple has multiple catalysts in the form of new products possibilities this year. They include two new phones (an iPhone upgrade and a cheaper iPhone), a TV market, and a “smart watch.”
When new products come, the market will realize Apple’s been using its huge cash hoard wisely already—on R&D!
In short: Apple, Inc. (NASDAQ:AAPL), Coach, Kors–all great companies. Sooner or later, Mr. Market will see that they’re all winners—it doesn’t have to be “either, or.”
Joy Global Inc. (NYSE:JOY)
Joy is a value play for those who like their investments spicy. The company makes mining products for many industries including coal–and boy, coal has taken a bath lately. Record low prices of natural gas have hammered the coal industry as utilities have gone “cheap.”
Despite being at the intersection of two slumping sectors (coal and mining) Joy actually had record earnings of $7.29 in 2012, as revenues surged 29%. Half of Joy’s business is in the aftermarket services of parts, which provides multiple “up-cycles” to win. Customers may hold off on buying new equipment, but sooner or later the old machines need repairs.
If you buy Joy, you should know that the market will attribute every price dip to “coal woes,” so you need to really believe—otherwise you’ll sell into panic. Here’s are a few points to reference when the panic sets in.
1). Despite the downturn in coal last year Joy earned $7.29/share–it lost $0.20 per share in 2002. Things weren’t bad in ’02; Joy’s business is just cyclical. Always remember that–it’s cyclical.
2). The coal industry is cyclical itself and is poised for a rebound. Exports are expected to emerging markets are expected to surge by 2020 and natural gas prices are bouncing slightly (yep, Nat gas is not renewable after all).
3). Joy has its financial house in order. The company earns a strong 31% return on equity–far above the industry average. This means it can weather cyclical storms.
But perhaps the best news is that despite the record growth last year, sales aren’t projected to dive this year. The next three years earnings estimates for Joy are at between $6-$7 a share. The stock hasn’t missed earnings estimates in many years. Once coals sentiment stabilizes, the stock should trade at a multiple near 14 (below the market and Joy’s historic average). And if analysts happen to turn a smidge bullish toward coal–watch out!
Working on your game
Understanding the cyclical nature of negativity can help you buy great stocks at cheap prices—but it’s just the start. This is a great tip you can use but, like a perfect golf swing, successful value investing takes a lot of work. Stay tuned, more tips (and picks) for your “value swing” are coming soon!
The article Tips (and Picks) For a Killer “Value Swing” originally appeared on Fool.com and is written by Adem Tahiri.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
