I want to develop a list of stocks that will be unaffected by the shutdown. Obviously anything related to travel, entertainment and energy is hit hard. Amazon, Walmart, Target and online retail are seeing a big boost in profits. Companies that make (or sell) home office equipment should be doing well as there is a temporary demand surge.
But how would you go about screening for the good companies and filtering out the not good ones. My models are all based on fundamentals. Fundamentals have changed and the models don’t have the new information. Garbage in, garbage out. Value and quality are using stale data. It’s a different world than it was three months ago. Earnings have changed.
How would you go about screening for companies that are good?
Great questions. Just a few off-the-top-of-my-head ideas . . .
Which industries did well in 2008? Utilities, tobacco, household products, road and rail, food products, food and staples retail, and insurance. I don’t see why those shouldn’t do well now too.
Not everything related to entertainment will be hit hard. Online gaming, for example, should do very well.
What measures will be least affected by the shutdown? Well, if revenue takes a hit, that doesn’t leave much; and since debt is going to be unbelievably cheap, we shouldn’t look at that either. My suggestions: industry momentum, accruals and related ratios, stability measures, gross margin, volatility measures (see my blog post about this: https://blog.portfolio123.com/2020/03/11/low-volatility-stock-picking-for-high-volatility-markets-a-multifactor-approach/ ), sentiment measures including short interest, momentum, R&D spending, and, perhaps most importantly, forward earnings yield based on next year’s estimate (once the analysts have had a chance to catch up).
Which industries did well in 2008? Utilities, tobacco, household products, road and rail, food products, food and staples retail, and insurance. I don’t see why those shouldn’t do well now too.
[/quote]I don’t know what you mean by insurance (thinking about AIG) but the rest is sort of okay, although I seem to remember reading somewhere that electric utilities have lost 20% of revenue.
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2. Not everything related to entertainment will be hit hard. Online gaming, for example, should do very well.
[/quote]Good point.
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3. What measures will be least affected by the shutdown? Well, if revenue takes a hit, that doesn’t leave much; and since debt is going to be unbelievably cheap, we shouldn’t look at that either
[/quote]Why is debt going to be unbelievably cheap? Once the bankruptcies start rolling in how will the lenders have a supply of money?[quote]
My suggestions: industry momentum,
[/quote]Okay.[quote]
accruals and related ratios
[/quote]Which related ratios do you have in mind? Also, what do past accruals ratios do for you when revenue is 0? If I recall correctly, your theory with accruals is that stocks with high cash flow relative to income tend to outperform expectations. Well, that theory goes out the window when revenue is 0.[quote]
stability measures
[/quote]What stability measures did you have in mind? [quote]
gross margin
[/quote]How would gross margins help?[quote]
volatility measures (see my blog post about this: https://blog.portfolio123.com/2020/03/11/low-volatility-stock-picking-for-high-volatility-markets-a-multifactor-approach/ )
[/quote]Low volatility stocks tend to underperform during the recovery phase. Besides, would you rather own a US water utility which has a very low volatility and a high PE or a ADR water utility that has high volatility (in line with the market in which it trades), but a very low PE?[quote]
sentiment measures including short interest
[/quote]Good. But limited when prices move 50% or more in a couple of weeks. short interest is published every other week.[quote]
momentum
[/quote]As a value investor, I am not as knowledgeable as I could be on momentum. But didn’t momentum have problems during bear markets? I am pretty sure that momentum does not do well in early stages of bull markets. [quote]
R&D spending
[/quote]I like this one.[quote]
and, perhaps most importantly, forward earnings yield based on next year’s estimate (once the analysts have had a chance to catch up).
[/quote]I don’t know if the analysts will be caught up before mid April if at all. Many companies withdrew earnings guidance.
I don’t thing people fully understand how much technology is involved with everything we do.
Did you buy any stocks today without using a little technology? You cannot build a marketable watch unless you have access to apps anymore. You cannot build a car unless you hire a machine learning programmer to develop the AI to drive it. You cannot be a doctor unless you tie your office into a machine that ultimately decides what treatment the patient is eligible for with their insurance.
And even if your product is something really simple one has to tie into technology to sell it. Some people on Wall Street are buying restaurants based on how well they can do takeout integrated with phone apps. I assume a lot of businesses need facebook or Google ads to survive.
Technology is tied to everything we do and it will continue to grow as fast, or faster than the economy as a whole–not matter what. It is largely unaffected by the virus, I would think.
In 2008/2009, after the initial drawdown QQQ and XLK had less of a drawdown going into March of 2009 and did very well afterward. I think these ETFs may have less short-term risk and do better than most coming off of the bottom.
I don’t see how big pharma could be hurt by this. Getting drugs on formularies is a complexity I do not fully understand but I suspect the insurance companies, the drug companies, the lobbyists and the politicians will all get a piece of a growing pie with our aging population.
I have a patient who could not figure out why her eye drop was $20 one time and $400 dollars the next. Turns out the GENERIC (travaprost) was $400 while the drug company and the insurance company had arranged for Travatan-Z (the brand name for the same medication) to be $20 with her insurance. I sat on hold for an hour with the insurance comany to figure it out. My bad, I had forgotten to write for the less expensive brand name on one of my prescriptions. Big pharma will do well.
Nobody even pays the same price anymore. It depends on which insurance (above), which site you go through (hotels) which cards you hold (groceries/Kroger cards in midwest), air miles, money back on credit cards, college tuition (SAT scores and online grant applications) etc. All controlled by technology.
And BTW, AI is increasingly being used to develop—or at least screen for–drugs now.
I was listening to Patrick O’Shaughnessey’s latest podcast and his interview with Gavin Baker, fund manager of Atreides Management. He brought up that everyone should be screening for how long a company can stay solvent with 0 revenue coming in the door, and that’s even a bigger red flag than outstanding debt because lenders don’t really want to drive people into bankruptcy right now if it can at all be avoided. So I’m guessing like cash on hand divided by net operational costs?
Obviously true. But Parker has said the stocks/sectors that are most affected during the drawdown are the one’s that will rebound the most.
If you agree with this last how do you take that into consideration?
As and example of this question (without an answer), when should I buy XLY or a consumer discretionary stock? I have had my finger over enter (buy) a couple of times and decided I do not want to be a hero and try to time this now. But still I wonder about this question.
I guess if I have had any answers at all they came during an interview with Bill Ackman. That consumer discretionary may be good if you are selective—e.g., picking the restaurants that can adapt. Ackman liked Chipotle, for example, because they were adapting with takeout, apps for takeout and delivery. He did think the price was too high at the time. So he was obviously being very selective. And he mentioned other things like a lot of food for a low price so he was not just focused on adapting unless he was thinking of the economy.
In 2008, the insurance industry as a whole (AIG notwithstanding) was one of the best-performing industries. [quote]
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2. Not everything related to entertainment will be hit hard. Online gaming, for example, should do very well.
[/quote]Good point.
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3. What measures will be least affected by the shutdown? Well, if revenue takes a hit, that doesn’t leave much; and since debt is going to be unbelievably cheap, we shouldn’t look at that either
[/quote]Why is debt going to be unbelievably cheap? Once the bankruptcies start rolling in how will the lenders have a supply of money?
[/quote] Not only are interest rates as low as they can get, the government is opening up lending restrictions and essentially giving grants right and left and actively trying to stop banks from going after defaulting businesses and shoring up other businesses and buying a huge number of bonds. [quote]
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My suggestions: industry momentum,
[/quote]Okay.[quote]
accruals and related ratios
[/quote]Which related ratios do you have in mind? Also, what do past accruals ratios do for you when revenue is 0? If I recall correctly, your theory with accruals is that stocks with high cash flow relative to income tend to outperform expectations. Well, that theory goes out the window when revenue is 0.
[/quote] Net operating assets divided by total assets, lower numbers better. That’s an accruals-related ratio I’ve written about a few times. Basically if you have low accruals/low NOA you have cash and non-debt liabilities to shore you up in hard times. [quote]
[quote]
stability measures
[/quote]What stability measures did you have in mind?
[/quote] There’s a short list in my volatility article. Personally, I look primarily at the stability of sales, operating margin, cash conversion cycle, investment (gross plant plus inventory), and income.[quote]
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gross margin
[/quote]How would gross margins help?
[/quote] It’s the best measure of a company’s “moat” if you measure against the industry.
Thanks Doctor for your valuable contributions. I hope that you don’t mind that I take the liberty of debating some of your points–not because I don’t respect your opinion, but because I believe that a healthy debate is valuable.
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…Technology is tied to everything we do and it will continue to grow as fast, or faster than the economy as a whole–not matter what.
[/quote]Interesting take Doc. I agree that it will grow as fast or faster than the economy. But how will the economy do? I don’t think people
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In 2008/2009, after the initial drawdown QQQ and XLK had less of a drawdown going into March of 2009 and did very well afterward. I think these ETFs may have less short-term risk and do better than most coming off of the bottom.
[/quote]Back then tech was reasonably priced. Investors still remembered the lessons of the dot-com crash well and were cautious. Today, QQQ is arguably priced for perfection. I don’t think we will be seeing perfection. Apple, for example, has shut down production.
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…big pharma…
[/quote]What happens when a noticeable percentage of their most lucrative patients (such as the ones with pre-existing conditions, or the ones who are older and presumably are using a lot of medications) succumb to Covid-19?
I don’t think that people have thought this through yet. It’s a whole new world. The silver lining is that I am expecting to have the investment opportunity of a lifetime coming up.
Thanks Yuval. Very interesting as usual.[quote]
Not only are interest rates as low as they can get, the government is opening up lending restrictions and essentially giving grants right and left and actively trying to stop banks from going after defaulting businesses and shoring up other businesses and buying a huge number of bonds.
[/quote]Yes, the government is trying to help as best they can. And they will save many. But others will not have it so good. Many REITs lost revenue, but their interest expense did not go away; although they may be able to push off the day of reckoning. You can also buy junk bonds with 20% yield to maturity. If they remain solvent, you will get interest and/or price appreciation of 20% annualized plus. But will they remain solvent?[quote]
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[/quote]What don’t you measure solvency more directly? Ex: Cash to expenses.
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How would gross margins help?
[/quote] It’s the best measure of a company’s “moat” if you measure against the industry.
[/quote]In other words, the stocks with the best moats are expected to come out ahead–assuming they remain solvent.
BTW, I expect cash to be a very valuable commodity during bankruptcies. Companies with excess cash will be able to buy out their competitors.
I am all about discretion, getting different ideas, abandoning bad ideas now. All great (and correct) points that I will put into the mix.
As Fisher says in one of his books you make a lot more money learning what you thought is right (along with everyone else) is wrong than from anything else. I would have to look up the exact quote but you may know it.
The only thing I could add about big pharma–as I implied with the Travatan-Z (travaprotst) example–is there is a bit of a moat or oligopoply/regulatory advantage/crony capitalism/lobbyist advantage. Not to mention that small drug companies are forced to merge to get on formularies, handle regulations, advertise to the physicians (the drug reps) etc.
How do I know with absolute certainty that there will be a better, more advanced medicine than hydroxychloroquine (whether it happens to work or not is immaterial)? Because hydroxycholoroquine is generic and big pharma cannot get a patent or a monopoly to produce the medicine.
You can bet your investing dollars on the last. Or that is my take anyway.
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I’m thinking a factor that can find out “earning cyclicality” or "earning stability’ would help. Does anyone have one?
[/quote]Consecutive years of positive EPS?
loopsum(“epsexclxor(ctr,qtr) > epsexclxor(ctr+4,qtr)”,6,0), higher values better. This one favors companies with consistent earnings growth every quarter (over the same quarter last year). It only looks back eighteen months, but you can change the 6 to something higher.
loopsum(“abs(opinc(ctr,ttm)-opinc(ctr+1,ttm))”,12)/(abs(opincttm+opincptm+opinc(8,ttm))), lower values better. This one favors companies that consistently earn the same amount every quarter (looking back 3 years). It’s probably best used to filter out companies with extremely unpredictable earnings.
Is this absolute high cash levels or relative to some other metric? There are companies like BBSI where the cash holdings are almost as large as the market cap.
Is anyone thinking about eliminating projected earnings in their ranks going forward? Analysts have absolutely nothing to base their projections on and are blindly throwing darts
[quote]
Is anyone thinking about eliminating projected earnings in their ranks going forward? Analysts have absolutely nothing to base their projections on and are blindly throwing darts
[/quote]Yes. I am also thinking of throwing out value, growth, and quality, which all rely on past earnings. Once 1Q earnings reports are released, we will have more to work with.
