It seems (to me at least) that celebrating the end of the week positively has been superseded by ‘Monday motivation’ trending more often on social media. Whether this is indicative of people being generally more frustrated and determined to overcome their perceived weekly strife I do not know, but whatever happened to just going with the flow and being happy? In a week where we had ‘Blue Monday’ (supposedly the most downbeat day of the year, not my favorite New Order song), equity markets in fact reached ANOTHER record high, and despite concerns about the ‘coronavirus', look set to close the week there - Happy Friday!
Whether my anecdote of the more commonly trending hashtags is accurate or not, the fact is that this is currently a great market for investors, and a good reason to be cheerful (anyone remembers 2008!?). That’s why in this week’s Trading Club video I focused on a new stock idea that I think should outperform over the next few months in this favorable market. I can’t reveal the name publicly just now, but I will gladly share some of our process with you, inspired by Lex’s Company Analysis model as he explains in the Million Dollar Traders Course.
Here’s how we analyse each of the 5 factors, considering the company’s management, products, financial health, valuation, and geographical exposure, before arriving at a total score out of 5.
The first step is to consider the management of the company. I appreciate that some people may not be as confident with spreadsheets, so I will provide a more visual representation for each of the sections using charts. Here you can see a recent transformation in the Return on Assets (ROA) which certainly looks like a turnaround situation, although there is no dividend which would otherwise suggest a ’shareholder-friendly’ board. On balance, we may conclude a neutral score on the management, given the positive ROA offset by the negative in the lack of a dividend.
Next on our Checklist are the company’s products. It doesn’t matter whether you are selling widgets or advertising space - you want to see evidence that the company’s products/services are in demand. Here you can see the clear trend in growth, punctuated by a base shift in 2016 owing to an acquisition. This is clearly positive, and there are apparent efficiencies that are being realised in the operating margin which has stemmed years of contraction and is now expanding at an attractive rate. Both deserve a '+1’ on our Checklist.
Financial health is vital if you are going to commit to owning a company through inevitable periods of volatility. The growth in Free Cash Flow is very healthy, and the company has transformed from generating a few hundred million in cash to a few billion each year. As an investor, you expect this to be distributed (awarded to you) in the form of dividends or buybacks over the course of time. It might also be used to pay down debt that the company owes, which it appears to have done recently. This is worthy of another ‘+1’ on our Checklist.
Lastly, we need to consider the all important market valuation. A great company may prove to be a poor investment at a sky-high valuation, so what we are ideally looking for is at least a reasonable valuation for a company that looks good on paper. Without getting too bogged down in valuation measures here (I explain this all further in the full video at lexvandam.com), whilst the 'earnings yield’ is slightly richer than the market (3.8% vs 4.6%), it does not look expensive compared to the stock’s own history (3.8% vs 3.8%). The Free Cash Flow yield is where the company starts to look like more of a bargain, affording a slightly higher yield to shareholders than the market (and, perhaps more significantly, superior growth expected in the numerator). There are a host of other measures you could use for valuing a stock (such as Price to Sales, or the PEG ratio for a growth-oriented company), but here we’ll conclude positively on balance with +1.
The 5th component is the geographical exposure of the company - i.e. where in the world the company generates the majority of its revenues. In the case of this stock, it is 100% domestically focused so there is not much to explain here other than how a concentrated play on the US economy is another plus, assuming we are positive on the latter (as we should be, according to our Business Cycle Checklist).
Let's conclude then with a quick look at the chart, which highlights resistance around $500, and support potentially at the prior 123.6% Fibonacci extension level ($450). Should the stock continue higher through $500 and hold, then according to this form of technical analysis, there may be a continuation towards an eventual target of $665 (around +33% from current levels, and +50% from the 123.6% level if you were to wait for a potential pullback).
Time will tell how this plays out, but rest assured that our Checklists and weekly Trading Club analysis will ensure that you are best prepared for the evolution in markets.
If you would like to join us for our full analysis including new insights each week, or learn from the ground up with online tuition from Lex in our MDT online course, then get in touch with us and take your financial knowledge to the next level right away!
Have a great weekend,
James Helliwell | Chief Investment Strategist