Why I Allocated Big Money to These Five Cheap Stocks

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I think that the Efficient Market Hypothesis was made up to keep the individual investor out of the market.   It says that the markets are informationally efficient to the degree that one cannot consistently earn market beating returns.  I, on the other hand, firmly believe that if you look deep enough there are always stocks that the market missed or underpriced.   To prove it I started a virtual portfolio I call the “No Drip, No Mess” portfolio which mimics how I invest my own money.

This portfolio is just four months old but I’ve uncovered a myriad of stocks that the market has mispriced.  I’ve allocated a large percentage of the portfolio and my reputation to five stocks that I think will handily beat the market over the long term.   I’m not just betting virtual dollars in these stocks but I’ve personally invested my hard earned income into them as well. I think each one will put the hypothesis to shame over the next few years.

Arcos Dorados (NYSE: ARCO)

The Mickey D’s of Latin America was trading at a 20% discount to their IPO price when I decided to buy this golden emerging market opportunity.  Since then shares have recovered a bit and are up 10% while the market is up by half that amount.  I wasn’t buying Arcos for a short term gain though; I bought because the addressable market of the company is just staggering.  They serve a market twice that of their former parent’s domestic marketplace but just have 2,000 stores verses the over 14,000 Big Mac Shacks we have in the states. That's a lot of future growth that the market is overlooking as it's too concerned about near term currency headwinds.

Arcos is not without risks and the company could have a messy future if the Latin American economy hits a real rough patch or if their currencies go haywire.  That’s why instead of investing hard earned cash into the shares, I invested my “no drip” cash which consisted of dividend and options income.  I took a full 1% position in the company which represents 40% of that side of my portfolio.  As more cash and no mess stocks are added to the portfolio that number will come down but shares were cheap enough that I felt comfortable making such a big bet on the company.

Apple (NASDAQ: AAPL)

I’ve twice added shares of Apple to my portfolio and have allocated 3% of my starting cash into their shares.  That sounds small but it does represent 15% of the actual virtual cash that I’ve invested at this point and still represents 4% of the total cash I’ve allocated if all options are assigned.  With more than a hundred billion dollars of cash on the books and shares selling at just 15 times earnings the company is very inexpensive compared to the opportunities that lie ahead.

While the iPhone and iPad get all the press, as they should, the market isn’t paying much attention to the potential for more Macs’ being sold into the Apple ecosystem.  Having bought both iDevices now, I plan on upgrading my laptop to the latest Mac as soon as it starts giving me trouble.  I’m not the only one that’ll be adding another device into Apple’s ever expanding ecosystem and I think the market is missing this trend.

Exelon (NYSE: EXC)

Some stocks are cheap for a reason; others are so cheap that the market, I think, makes them cheaper because they don’t know what else to do.  That’s where we find Exelon these days and that’s why they are the one utility I’m buying.  I started off by buying a 1.5% allocation outright and wrote a put to bring the allocation up to 5% of the portfolio. 

Exelon yields nearly 6%, well above the 4.6% average yield from their peers.  On a yield basis alone Exelon is 38% undervalued which is unjustified when you look at the company’s clean energy profile and the benefits from their merger with Constellation.  When you combine their yield with their potential to simply revert back to the industry average Exelon could smash the market’s returns over the next few years.

Intel (NASDAQ: INTC)

I originally wrote puts on this tech giant to earn a little options income and eventually buy shares cheaper.  Well as shares have become cheaper I decided to double down on this cheap tech titan and write more puts.  As shares continue to fall I’m quite honestly considering a tripling down of my bet on this extraordinarily well run company.  The closer shares get to $20 the more likely I’ll look to push my allocation into an overweight situation.

Shares are trading at less than ten times earnings and the dividend yield is now over 4%.  The market is pricing Intel as if we’ll never buy another PC again.  I think that investors are forgetting that Mac’s run on Intel chips and while some are replacing PC’s with tablets, you simply cannot replace all of them as certain functions cannot be done with the same productivity on an iPad.  One day the market will realize that Intel is not dead and those who buy at today’s levels will be greatly rewarded.

Medical Properties Trust (NYSE: MPW)

Sometimes it pays to be in the right stock at the right time.  I bought shares of MPT right before the Supreme Court ruled on the ACA.  I wasn’t looking to play the court case but I thought that the market was missing the fact that this Real Estate Investment Trust was a safe and secure way to invest in health care.  By owning the physical hospital buildings and signing triple net leases at more than a 5.5 times lease coverage ratio their income was safe no matter what happened to the future landscape of health care.

After an initial pop following the ruling, shares have been the best performing investment in the portfolio returning 28% vs. just a 9% return from the S&P.  I initially virtually invested 3.6% into the company but the capital appreciation now has the company occupying 4.5% of the portfolio.  I still think shares have plenty of room to run and they recently received a high profile endorsement which should keep the momentum going for a while. 

I still like all five companies at current prices and plan to hold them all personally for decades to come.  Because of the value the market is placing on them right now it has brought their respective dividend yields into very respectable territory.  Being paid while you wait for the market to remember it’s supposed to be efficient is one of the best facets of the supposed efficient market hypothesis.


latimerburned owns shares of Apple, Medical Properties Trust, and Arcos Dorados and has the following options: Apple, Intel and Exelon. The Motley Fool owns shares of Apple, Arcos Dorados, and Intel. Motley Fool newsletter services recommend Apple, Exelon, and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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