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January 16, 2018
Viewed 129 times.

Sometimes, investment ideas can come from monitoring trends. This week, we noticed a new trend appears to be at work. Combining this with some other long term trends in the market results in a short list of stocks that could be among the market’s biggest winners in the short run, and the best option of investing in stocks.
One of the long term trends in the stock market is the increasing importance of global economic diversification. This can be applied to stock selection by analyzing a company’s sales. Companies with a significant amount of foreign sales will be the global companies poised to benefit from this trend.
Testing the Value of Foreign Sales for Large Companies
According to FactSet, a research firm, “coming into the Q3 earnings season, companies in the S&P 500 with higher global exposure are expected to benefit from the tailwinds of a weaker U.S. dollar and higher global GDP growth.”
The research firm maintains a database showing Geographic Revenue Exposure based on the most recently reported fiscal year data for each company. In a recent research report, stocks were divided into two groups: companies that generate more than 50% of sales inside the U.S. (less global exposure) and companies that generate less than 50% of sales inside the U.S. (more global exposure).
Further analysis was then done to find that companies in the S&P 500 with higher global revenue exposure are expected to deliver stronger growth in sales and earnings than S&P 500 companies with lower global revenue exposure.
The results are actually rather dramatic. Companies with a majority of sales in the US are expected to report a contraction in earnings and sluggish growth in revenue. Companies with a majority of sales outside the US account for all of the expected growth in earnings in the index for this quarter.
Generating Trading Ideas From That Research
While this is useful information, it is possible the information could be even more powerful when applied to stocks trading at lower prices than those in the S&P 500. This can be done by limiting our search to low priced stocks. These stocks are likely to deliver the largest short term percentage gains.
To find potential buy candidates, we can screen companies using the free screening tool at FinViz.com. This tool allows us to find companies meeting a variety of criteria. For this screen, we will look for low priced stocks with substantial global exposure.
FactSet is a more sophisticated data analysis tool and has significantly more capabilities than free tools. To find companies with foreign exposure, we will need to use a different approach than the one applied in the study summarized above.
We will limit our search to companies traded on US exchanges that are headquartered outside the US. This will allow us to find companies which are likely to experience most of their growth outside the US.
The fact that they are headquartered in other countries indicates they have significant business operations there. The fact that they are listed and available for trading in the US shows that they also have substantial operations in this country.
We will also search for stocks trading below $5 because stocks at this price are more likely to deliver large gains, in percentage terms, than stocks trading at higher prices. We will also limit our search to stocks with a significant amount of institutional and insider ownership, at least 20% on each measure.
High institutional ownership shows that large investors have done research on the company and determined that it is a buy. Large insider ownership shows us that that the managers of the company have faith in its operations.
Without access to more sophisticated research tools, these two factors can tell us what the research reports likely say. Institutions tend to sell when research reports are neutral to negative. Insiders tend to sell when long term prospects dim.
Finally, we limited our search to stocks with low volatility. We used beta to measure volatility and required the stock to have a beta of less than 1. This avoids the most volatile stocks which carry higher than average risk of loss.
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January 9, 2018
Viewed 264 times.

Value investing has an appealing logic to many investors. The idea is simple. Value investing generally involves searching for stocks trading at discounts to their fair value. These stocks can be bought and held until they trade at or above their fair value.

These ideas were first put forth by Benjamin Graham, a business school professor who counted Warren Buffett among his students. Graham is widely considered to be the father of value investing and he wrote widely on the topic. His work includes descriptions of strategies that he found to be successful.

Graham developed and tested the net current asset value (NCAV) approach between 1930 and 1932. He later reported that the average return, over a 30-year period, on diversified portfolios of NCAV stocks was about 20%. An independent study showed that from 1970 to 1983, the strategy gained an average of 29.4% a year.

What Is NCAV?

Graham defined NCAV in the 1934 edition of Security Analysis, the book he cowrote with David Dodd. He said NCAV is equal to “current assets alone, minus all liabilities and claims ahead of the issue." In accounting terms this is current assets minus the sum of total liabilities and preferred stock.

Current assets are cash and cash equivalents, receivables, and inventories. They are already cash or are convertible into cash within a relatively short period of time (usually less than a year). Net current assets exclude intangible assets along with the fixed and miscellaneous assets of a firm.

Some readers may see a similarity between NCAV and working capital which is defined as current assets minus current liabilities. The difference is that NCAV deducts total liabilities (current and long-term) from current assets. 

Compared to book value, the NCAV method is a more rigorous standard. Book value can include intangible assets, which can be overstated in value. Book value includes land, property and equipment which can take considerable time to convert to cash.

In their book, Graham and Dodd pointed out that when stocks trade below the company’s NCAV they are, most likely, trading below the company’s liquidating value. This means that it is reasonable to assume that most companies can be sold off for at least the value of these assets.

They also noted there was a margin of safety in the company’s remaining assets, fixed assets like plant, property and equipment. These assets could, in time, be sold to offset any loss incurred when converting the current assets into cash.

Graham and Dodd created an investment strategy based on NCAV. When they found companies trading well below their liquidating values, they bought them.

Screening on NCAV

In the 1949 edition of his book, "The Intelligent Investor," Graham explained exactly how to screen for buy candidates. He wrote, "…if a common stock can be bought at no more than two-thirds of the working-capital alone—disregarding all other assets—and if the earnings record and prospects are reasonably satisfactory, there is strong reason to believe that the investor is getting substantially more than his money’s worth."

To find a reasonably satisfactory earnings record, we required companies to have positive earnings per share from continuing operations for the past12 months.

Earnings can hide operational difficulties since there can be accounting assumptions that generate earnings for some companies. To minimize this risk, we required that companies also have positive operating cash flow over the last 12 months. Cash from operations is defined as revenues less all operating expenses.

Graham also believed low debt levels would help these companies survive. Therefore, we screened for companies that have total-liabilities-to-total-assets ratio below 50%. This confirmed companies have more assets than liabilities.

We then screened for low prices, less than $2 a share. However, these stocks can be illiquid with low trading volume. Despite the risks, this can be a useful approach, again, in the long run. As Graham wrote in the 1973 edition of "The Intelligent Investor":

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