2019 finishes with an extra kick for investors. Part of that is the continued strong run of the market, erasing memories of last year's near bear market and extending the decade-long bull. There also are plenty of market headlines and events that have sprung over the end of the year, from Phase 1 trade deals to M&A to political whirlwinds and more.
More trivially, the 2010s are ending and the 2020s begin. It's been quite a decade for equity investors, with the S&P 500 returning more than 250% in that time. Even underperformance could leave a portfolio in good shape, and any alpha that was found would really leave investors well off.
Where does that leave investors and the markets for 2020, at the start of a new decade? That's what we try to answer in our annual Marketplace Roundtable series. We are publishing roundtable discussions featuring more than 80 authors from across the spectrum of investing styles and focuses you find on Seeking Alpha: Macro to value investing, small cap to energy, gold to quant and alternative strategies, and more.
Today's discussion is the first part of a two-part focus on value investing, our most popular category for this year-end series, perhaps due to the wide definition the style can cover. We're featuring the following panel:
- Bill Zettler, author of Turnaround Stock Advisory
- Howard Jay Klein, author of The House Edge
- Mark Hake, CFA, author of Total Yield Value Guide
- Grant Gigliotti, author of Good Stocks@Bargain Prices
- Mark Bern, CFA, author of Friedrich Global Research
- Value Digger, author of Value Investor's Stock Club
- Chris Lau, author of DIY Value Investing
- David Krejca, author of Global Wealth Ideation
- Dining Stocks Online, author of DSO Restaurant Analysis
- J Mintzmyer, author of Value Investor's Edge
Bill Zettler: The economy continues to grow modestly, unless there's a war in the Middle East or Korea.
Howard Jay Klein: I remain bullish. The GDP growth is not overheated, jobs growth is strong, consumer spending is not wildly draining savings, home equity loans are tracking fairly constant. Overall, I think the economy will turn in a reasonably stable performance in 2020.
Mark Hake, CFA: Corporate profits are growing nicely, inflation is low, interest rates are low, and most importantly, cash flow is increasing in most major companies. This is a formula for an even higher stock market index price. That also could mean that the market becomes a bit overvalued, but that's not unprecedented.
Grant Gigliotti: I look at total market cap to GDP to see how overpriced the market is, and if there's quick movement downward, I will likely exit investments that I'm less confident about. Currently, total market cap to GDP is around 147%, which indicates that the market is significantly overpriced.
Mark Bern, CFA: Neutral for 6-12 months until we see how the trade deal with China turns out. Bearish for the intermediate term of 13-36 months, but bullish beyond that for the longer term.
Value Digger: This time is not different. Most sectors are very expensive, and perception will catch up with reality sooner or later, as always.
Chris Lau: As a value investor, I get it. FOMO, or fear of missing out, is a sentiment we are used to feeling. And right now, the relentless market rise is rewarding everyone who is bullish. Yet, the tide will eventually turn, and markets sell stocks. Stay disciplined and true to buying stocks at a discount and selling them when they reach full value.
David Krejca: Over the last two years, I have honestly not paid close attention to the broader indices, but I noticed that many companies' earnings have slightly decelerated. However, I have no idea how this can evolve in the future - earnings trends and share prices can be disconnected for a long time. Nevertheless, equities as an asset class became quite expensive in relative comparison with commodities, so I wonder whether there will be some kind of pivot.
Dining Stocks Online: We don't see much concern out there as evidenced by low volatility and mostly bullish market outlooks for 2020 (mid to high single-digit gains) by most market strategists. We see political risks depending on who the 2020 nominees are and what the polling looks like in the first half of next year, but at this stage, there's little reason to think the fundamentals are set to change soon.
J Mintzmyer: I've been skeptical about broad market valuations for the last few years, but if we peel back the highest performing 20-30 names, most of the core valuations aren't very high compared to historical levels, especially when considering the interest rates are low and globally likely going lower. Furthermore, there was a report issued by Barron's in October ("Big Money Poll") which logged the lowest percentage of bulls (27% overall) in more than 20 years. Major stock market collapses almost never happen when everyone says "there's about to be a crash," so this was an incredibly bullish headline to me.
What's a lesson you learned in 2019?Bill Zettler: Be patient.
Howard Jay Klein: Headline events seem to trigger more knee-jerk reactions in the market than they seemed to produce in past years. The massive expansion of media is both a blessing and a curse to stock market valuations based on fundamentals.
Mark Hake, CFA: Stocks that bought back their shares on a consistent basis tend to do quite well, as opposed to those that try to time the market.
Grant Gigliotti: Tariffs, combined with an irrational and unpredictable president, can cause all kinds of instability in the stock market and individual stocks. It also can provide opportunities for value investors to acquire mispriced stocks.
Mark Bern, CFA: High-frequency trading and corporate buybacks have ruled the market. Headlines have driven market action in 2019 more than fundamentals to an extent I have not seen before for such an extended period.
Chris Lau: Betting that the Fed would not raise interest rates and, in fact, cut it paid off. DIY Value Investors learned that the market will reward investors for betting that a sector will outperform and will provide a positive return. Dividend-growth income stocks did well. Sure, technology stocks did better, but some investors preparing for retirement prefer steady dividend income.
David Krejca: Know the difference between "money" and "currency" and be aware of what it means and how it feels in context of investing and trading. Also, recognize and differentiate between a speculation (successful) and an investment, the latter usually requires more work, whereas the first luck.
Dining Stocks Online: Even more than 10 years into an economic cycle, with negative to flat earnings growth, valuation multiples for equities can still expand when investors have minimal better options.
J Mintzmyer: Don't over-complicate a thesis. I made a lot of money in 2019 with shipping stocks (my two model portfolios are up an average of 61% YTD), but where I did the best was with super simple plays: Good management, good balance sheets, and good market exposure. The most complex stuff I picked, which required multiple catalysts to occur, all lagged considerably.
For a few weeks at least in September and October, it seemed like value as a factor was making a comeback. Head fake or start of a trend, or does it not matter?Bill Zettler: No
Howard Jay Klein: Value is constantly held hostage by overreaction to headlines, as noted before.
Mark Hake, CFA: Value stocks, especially with catalysts like large buyback programs, will always do well over time. I'm not so much concerned about short-term fluctuations.
Grant Gigliotti: In my mind, value investing is not a fad that goes out of style or makes a comeback. It will always be a wise choice to buy quality products that are selling at a discount. In the same way, it will always be wise to buy quality stocks selling at bargain prices.
Mark Bern, CFA: We focus on free cash flow generation and the long-term prospects for growth on individual stocks, so overall market trends are less relevant to our strategy. We do monitor major macro indicators, trends and events to keep from being on the wrong side of a major move. Significant potential events such as the US-China trade negotiations, Brexit and impeachment are on our radar and keeping us cautious until resolved one way or the other.
Value Digger: We would call it "selective rotation." Some investors dump their grossly overvalued names in this expensive stock market to lock in profits and buy selectively some overlooked and grossly undervalued companies, primarily small caps and micro caps. We expect this to continue in 2020, and we do have in our list obscure, grossly undervalued companies that have strong catalysts ahead.
Chris Lau: Markets recognized value in the sectors the DIY Marketplace service specializes in: Biotechnology. Year to date, biotech only broke even after the monster comeback in September and October. Regeneron (REGN) and Bausch Health (BHC) did well, as did AbbVie (ABBV). Ignore trends and momentum: Pick undervalued stocks and markets will eventually reward you for waiting.
David Krejca: I believe value provides one with a certain degree of safety, although growth is a lot more seductive.
Dining Stocks Online: Stocks will still move on individual fundamentals, but as value-oriented investors, we are glad to see that some of the money-losing growth stocks are stagnating or even falling materially. When those areas are red hot, value will be ignored. When they begin to fade, we think investors will look more broadly for market opportunities outside of the flashy, momentum-based names.
J Mintzmyer: 2019 has been incredibly profitable despite still almost fully allocated to value names because we had the benefit of being in the right sector (shipping) at nearly the perfect time. If you can find expert sector coverage and make wise risk-adjusted allocations, it doesn't matter how "value" is performing against "growth." That's really more of an issue for someone who's simply buying an ETF or two. Yes, the past decade has been brutal for "value," but there have been dozens, if not hundreds, of massive value winners during this time.
How important do you view hedging portfolio risk, and how do you go about it?Bill Zettler: Selling calls.
Howard Jay Klein: I'm not a fan of hedging as I believe the skill set and resources required to make smart hedging positions are not readily available to the mass of investors. It's fine for institutions.
Mark Hake, CFA: Not very interested in that. I recommend sticking with long-term investments and average cost investing when they fall below your original investment cost.
Grant Gigliotti: Benjamin Graham said something along the lines of diversifying among good investments can provide protection, but diversifying among so-so investments can add more risk to your portfolio. I believe in buying good companies at bargain prices. I thoroughly review the companies that I invest in. This is how I hedge my risk, by buying more than one quality company that I'm confident about. If you're spreading your money into multiple investments just for the sake of diversifying or hedging your risk, but you don't understand these investments and aren't confident about them, then you are actually increasing your risk.
Mark Bern, CFA: We offer subscribers some potential short candidates to consider, and I personally like using out-of-the-money put options to hedge risk when the market is facing potentially higher volatility. We look for companies that, because of negative free cash flows and high debt, are likely to come under stress (usually due to overpaying for acquisitions) and for cyclical companies that tend to fall faster than the overall market during periods of economic contraction.
Value Digger: Hedging is a key success factor in the stock market. This is why we have been providing our subscribers with long ideas and short ideas from a wide variety of sectors (i.e. healthcare, technology, industrial, mining, energy, consumer goods).
Chris Lau: DIY Value Investing is long-only and does not hedge. I show my subscribers that holding cash is the easiest, least expensive way to hedge. Raise cash and hold bond ETFs and then wait for opportunities when risks rise. Then, buy more stocks and average down when appropriate.
David Krejca: Do not depend on a single company, build a portfolio so that idiosyncratic risks reduce the overall risk exposure
Dining Stocks Online: Each investor's portfolio should be constructed based on their return goals and stomach for volatility. If that's the case, there's no need for hedging. If it's not, we would prefer to change the portfolio construction rather than panic and hedge just to feel more comfortable.
J Mintzmyer: I personally don't do a lot of "active" hedging, but I play a good amount of portfolio defense by limiting my allocation to speculative investments to around 30% of my net assets, keeping significant dry powder available, and using margin judiciously. When markets are crashing (Q4-2018 comes to mind), my speculative names are painful, but if I picked good names to begin with, those values will rebound (as they did for 90-95% of my names in 2019), then it's a matter of cutting out the losers and mistakes and moving on.
What's one factor in a company you always look for before making an investment? Or one factor that always turns you away?Bill Zettler: Free cash flow.
Howard Jay Klein: EV/EBITDA: In my sector, it's the closest to a golden metric that reveals true value.
Mark Hake, CFA: I always look to see if the company has a history of generating free cash flow, pays a dividend, and buys back its own shares. In addition, if the company has net cash on its balance sheet or at least only a small amount of net debt in relation to its cash flow, that's also attractive. I turn away from companies with the opposite of these metrics.
Grant Gigliotti: I want to see that the company has been around for at least 10 years and has had at least five years of consistent and upward growth in earnings.
Mark Bern, CFA: One factor that's a must is consistently strong free cash flow generation with a high return on free cash flow invested capital. The major factors that turn us away include negative free cash flow combined with excessive goodwill and debt.
Value Digger: Actually, our checklist is long, and a company has to tick all the boxes before we buy it. One factor is never enough. But since we have to start with one factor, we will look for the cash flow report. We want the company to have positive operating cash flow and free cash flow or to be close to generating positive OCF and FCF when it comes to our bullish ideas. High leverage and/or hype will always turn us away when we are looking for bullish ideas. But high leverage and/or hype will always attract our interest when we are looking for bearish ideas, so we will continue our due diligence because this highly leveraged or overhyped company could be an excellent short candidate.
Chris Lau: Look at how management treats its investors. If insiders are both buying company stock and maximizing shareholder returns whenever possible, then consider investing in them. Empty promises from CEOs are one factor DIY value investors should watch out for. Avoid those stocks.
David Krejca: Valuation - how much does the company trade with respect to its future expected cash flow, historical fundamental multiples and peers?
Dining Stocks Online: Capital allocation. First, you have to earn free cash flow, then you need to spend it wisely. Companies that create shareholder value consistently tend to excel at capital allocation, or at least avoid material mistakes.
J Mintzmyer: I always look to a management's capital allocation priorities, history of performance in their segment/niche, and overall accessibility. Are these teams growing to grow, or are they focused on maximizing per-share valuations? Are they generally the sharpest pencils or the dimmest light bulbs? Are there any related-party conflicts or weird compensation structures to worry about? Is management accessible and transparent or do they hide behind weak IR or multiple layers of bureaucracy? Those questions need to be addressed before moving forward into further layers of coverage.
Have you added any new steps or considerations to your investment process in the past year, and if so, what is it and why?Mark Hake, CFA: I have made some adjustments to my measurement of free cash flow. Some companies are not using "adjusted FCF" by also deducting required pension or lease obligations from FCF (i.e. operating cash flow less capex). Amazon (AMZN) is doing this. I'm also using TTM FCF much more, on a quarterly basis, to project out future increases in FCF. Lastly, I'm more and more focused only on companies that have large buyback programs (net of employee share issuance) in relation to their market value. These stocks tend to do well over time.
Grant Gigliotti: Since I feel that the market is significantly overpriced, I have added a step of seeing how the stock has typically performed during times of recession. I also think about whether customers will continue buying the same amount or more of this company's product or service during times of recession. Because a significant market correction is inevitable, I'm trying to only buy the companies that have a better likelihood of performing well during market recessions and downturns.
Mark Bern, CFA: Not really. We continue to look for consistently superior execution by quality management of companies that have strong, sustainable business models.
Chris Lau: The DIY Value Investing service proactively encouraged members to submit their stock ideas and then I would research them. Some of the very best picks came from DIYers. Okta (OKTA), Zuora (ZUO), and XBiotech (XBIT) are a few examples of stocks that benefited the other subscribers.
David Krejca: Think of investments more from sustainability, longevity, accounting and tax perspectives.
Dining Stocks Online: As computers take over more of the daily trading volume, we are seeing ever widening gaps between fundamental valuation analysis and daily stock price quotations. Markets are in a way becoming more inefficient due to algorithms because they tend to consider factors that are irrelevant to the present value of future cash flows (the heart of stock prices). As such, we are quicker to see near fair value than in prior years. If something gets to within 10% of our fair value estimate, and we don't see the security as a long-term buy and hold situation, we strongly consider selling and not holding out for that last 10%.
J Mintzmyer: As I mentioned in the broad overview, my biggest lesson learned in 2019 is that the investment thesis has to be very simple, and the catalysts have to be smooth. The complex theses with multiple potential points of failure have rarely worked out for me, but most of my sector coverage has done exceptionally well. It really is that simple, and yes, I'm disappointed it took me over a decade of active investing and trading to come to this conclusion!
I used to give myself about one or perhaps two minutes to explain an investment thesis to others to determine if it was a good idea or not. If I can't explain the idea or company in 20-30 seconds, the stock isn't making my cut for 2020. It doesn't mean the research behind the idea is basic, but the actual core idea has to be very straightforward.
What are you focused on in 2020?Bill Zettler: Oil.
Howard Jay Klein: Three areas: Mergers and consolidation in US gaming, recovery in Asia gaming, and sports betting pure plays emerging.
Mark Hake, CFA: I'm more focused on total yield growth stocks than ever before (i.e., those that have growth in both their dividends and buybacks as a percent of the market value). Interestingly, I have found that those companies that specify the number of shares they are going to repurchase, rather than a dollar amount, over a specified period of time (and thus are really tied into a commitment) tend to have stock price rises over time, despite short-term fluctuations in their underlying financials.
Grant Gigliotti: I will continue to be focused on value investing - buying good companies at bargain prices.
Mark Bern, CFA: We will look for undervalued companies with strong potential revenue and cash flow growth well into the future. Those are the factors that generally lead to an expanding bottom line and the stock price eventually follows earnings.
Value Digger: We focus on a bunch of things in this very expensive stock market. For instance, we focus on the U.S.-China trade war, the political uncertainty in the U.S. due to the upcoming elections, Brexit, updates from U.S.-Iran, marijuana developments, etc. We have experienced 100% success with our bearish ideas since December 2015 when we launched our value research, and we want this success to continue with excellent short ideas in 2020 too.
Chris Lau: In 2020, the service will provide more repeat coverage on core top DIY stock idea holdings. Just because the stock keeps going up, it does not imply that detailed coverage should be put on pause. For example, BP plc (BP) is a long-time dividend income play. And with energy out of favor for so long, it's time for this sector to sustain a rebound this time.
Dining Stocks Online: Finding values in the marketplace, as always!
J Mintzmyer: My research platform, Value Investor's Edge, is focused on the shipping sector and that is my "lane." One of the biggest previous lessons I've learned (thankfully early) is that I absolutely have to stay in my lane, especially if I'm writing reports. However, what we do is hire consultants or partner with others who are experts in other areas. I'm very bullish on shipping still, but as of mid-December, my model portfolios are up an average of 61%.
I believe selective energy plays have similar, or perhaps even greater, return potential for 2020, but I'm not the expert in energy. Therefore, I'm working closely with Michael Boyd, of Energy Income Authority, to determine which of these companies are worth allocating speculative funds into.
What's a favorite idea for 2020, and what's the story?Bill Zettler: Oil will go up as OPEC cuts and shale capex shrinks.
Howard Jay Klein: Consolidation in the US gaming space will create multiple opportunities for investors.
Mark Hake, CFA: My favorite idea is Expedia (EXPE). Barry Diller has retaken the reins of the company and ousted the non-performing CEO and CFO. Moreover, EXPE announced a 20 million share repurchase program on top of their existing 9 million share buyback program. This represents 20-22% of the stock's market value, depending on how fast the stock rises. In addition, Barry Diller is also committing to buy more shares for his own account, even though he controls 49% of the voting power of the company. This will have a secondary effect of reducing float just like a buyback. The company consistently makes $1.1 billion to over $1.4 billion in trailing 12-month free cash flow. The dividend (yield is 1.3%) costs $200 million. So, EXPE could afford to do the whole 29 million shares, which would cost $3.67 billion or more in 2.5 to 3 years, since it would have $1.2 billion excess FCF to spend on buybacks. That gives the stock a total yield of over 12% (dividend yield plus buyback yield) annually. The buybacks alone will push the stock higher just from the buying pressure and the reduced float.
Grant Gigliotti: I've been strong on Big Lots (BIG) and buying around $20, when possible. I've felt that it's very undervalued and see the real valuation of around $30-plus. The market is beginning to realize it, and the stock is starting to climb.
Mark Bern, CFA: We are being cautious at Friedrich Global Research and focusing on companies that are less dependent upon theglobal marketgrowth. Ryman Hospitality (RHP) is a recent addition based upon strong free cash flow, falling future capital expenditures, and expected revenue growth. A nice, 4% rising dividend doesn't hurt, either.
Value Digger: My favorite idea for 2020 is bearish. I'm very bearish on CrowdStrike Holdings (CRWD) at the current price of $50 per share. CRWD is massively overvalued at $50 per share due to a combination of company-specific and sector-specific reasons. You will find more key information about this bearish call in my article that's expected to be out by the end of 2019.
Chris Lau: The election year will not bring more volatility and uncertainty as markets expect. The US-China relations will not change, either. So, avoid macro investing and hone in on strong segments of the market.
David Krejca: Delek Drilling (OTC:DKDRF) - energy oil and gas company - developing a major natural gas field reservoir in the Eastern Mediterranean Sea. The company has built critical infrastructure and intends to start commissioning first gas. There are great differences between the prices of natural gas in Europe, the U.S. and Asia, so the only question that remains is the pricing.
Dining Stocks Online: We really like Jack in the Box (JACK) as a value-based restaurant play in 2020. The stock is sitting near its lows, but a strong buyback is in place, and management is focused on growing traffic and new units after spending years trying to grow Qdoba (now sold) and running a distracting strategic review process. We see free cash flow per share surging over the next 1-3 years, and the stock trades for less than 10 times our estimate of free cash flow a few years out. Other franchised businesses trade for 2x-3x that valuation.
J Mintzmyer: One of my favorite ideas for 2020 is an extension of one of my favorite ideas in 2019, which has been wildly profitable, nearly a three bagger: Dorian LPG (LPG). The lowest hanging fruit has been obviously plucked, but the rates are still enormous, and the stock still trades below its net asset value ("NAV"). Most importantly, the VLGC trade routes are growing between the US and Asia, and the recent US-China Trade Deal should be very beneficial to further shipping demand growth. They don't pay a dividend yet, but once they've fully stabilized the balance sheet, I expect we'll see impressive returns, which should drive further valuation premiums. I don't expect a repeat of the 2019 performance (nearly 3x!), but this one is very simple and clear to follow.
***
Thanks to our panel for sharing their views on the state of value heading into 2020. You can find more of their work here:
- Bill Zettler, author of Turnaround Stock Advisory
- Howard Jay Klein, author of The House Edge
- Mark Hake, CFA, author of Total Yield Value Guide
- Grant Gigliotti, author of Good Stocks@Bargain Prices
- Mark Bern, CFA, author of Friedrich Global Research
- Value Digger, author of Value Investor's Stock Club
- Chris Lau, author of DIY Value Investing
- David Krejca, author of Global Wealth Ideation
- Dining Stocks Online, author of DSO Restaurant Analysis
- J Mintzmyer, author of Value Investor's Edge
We continue our look at value investing in the year to come tomorrow with the second half of this two-parter. And then, our compiled top picks for Marketplace authors will come out Monday. Watch for that, and thanks for reading!
See also Coronavirus And Results: Finally Some Catalysts For Gilead Sciences on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
