How to Find Long and Short Investment Gems
RJ is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Valuentum's stock picking methodology, the Valuentum Buying Index (VBI), looks at many factors before arriving at a rating, including a firm's relative valuation measures and the discounted cash flow model to name a few. This focus on different approaches left us very intrigued by a recent Harvard Business Review article. In the October 2011 issue, there was an interview with Michael J. Mauboussin (Chief Investment Strategist at Legg Mason Capital Management) on his views regarding complexity. This is what he had to say:
If you're an investor and you're only looking at your Bloomberg terminal and reading Forbes and Fortune and the Wall Street Journal, it's unlikely you're going to get a lot of really interesting ideas. You need to read and think more broadly. Great investors most definitely do that already.
Investors and even analysts can become overly focused on one variable or one approach, leading to neutral or even poor results compared to the market. When markets are working efficiently, changes in a company's performance or dividend may already be reflected in the stock price. Because of this, the well-known, tried and true companies may provide stability and certainty, but they may not provide the most incentive to investors. On the other hand, a small or unknown company may provide all risk and no reward. What is an investor to do?
In this complex and intertwined world, investment ideas come from many sources, and looking outside the box - outside the investment world - is a must. Alternatively, applying a cross-section of disciplines, such as that of 'Valuentum' investing, is another way to identify those names that may be of significant future interest to investors but have yet to converge to their intrinsic worth.
We highlight some of our best ideas below that came from looking beyond traditional news and employing our fresh, unique investment process.
EDAC Tech (NASDAQ: EDAC)
Why it piqued our interest: We first became interested in going long EDAC Tech last year when we wrote on some of the best ideas in the commercial aerospace supply chain. We knew the aerospace cycle during the next few years would be robust, and we were surprised to see EDAC Tech trading so cheaply from a valuation standpoint. The firm had a huge and growing backlog, and from our experience in the aerospace supply chain, EDAC Tech would experience substantial operating leverage as throughput increased. The company's market cap was roughly $20 million, so it didn't fall on many investors' radar screens. But that didn't stop us from profiting. We highlighted the company as a best idea to our subscribers, and the firm subsequently tripled in price. On the basis of our robust DCF process, we expect EDAC Tech to double again from today's levels.
AMR Corp (NASDAQOTH: AAMRQ.PK)
Why it piqued our interest: We first became interested in going short AMR Corp, the parent of American Airlines, a year ago when we wrote on why we thought the firm's equity was practically worthless. At the time, many sell-side analysts and independent research shops were still bullish or neutral on the airline space. We were surprised, to say the least. However, our fresh thinking led us to believe that a significant decline in AMR would be in the cards, as its current free cash flow stream was nowhere close to being sufficient to create any value for shareholders over the long haul. Though American Airlines is a firm that many investors have heard of, our process and view on the poor industry dynamics of the airline industry led us to develop an iron-clad thesis on the firm's valuation. As a result, we highlighted to our subscribers the firm's impending decline, and AMR has subsequently declared bankruptcy.
Netflix (NASDAQ: NFLX)
Why it piqued our interest: This is a firm that many, many investors know very well after the well-documented missteps by management. However, before the significant share price fall, we were one of the only firms pounding the table that a massive decline was coming. In fact, we challenged the investment community in our July 2011 article when the shares were trading at about $250 each to arrive at a valuation that was anywhere near Netflix's current share price (please view our Valuentum profile to access that article). Simply put, our research advantage with respect to valuation analysis allowed us to uncover this short-idea gem, as other firms remained enamored with its potential growth prospects. Our differentiated investment process allowed our subscribers to steer clear of this landmine and avoid a massive sell-off that has left Netflix's shares wounded.
So what do we think of Netflix today? Well, we think the firm is fairly valued. Please click on the front page of our 16-page report below for more details regarding our valuation assessment of the company.
Apple (NASDAQ: AAPL)
Why it piqued our interest: Okay, yes, this is a name that probably has found its way into everyone's portfolio at some time or another -- so it is not hidden. But what is hidden are the best entry and exit points in this behemoth of a stock. Our process allowed us to pinpoint a near-term bottom in Apple's share price, as we noted in our June 17, 2011 article that the iPad-maker was reflecting nothing more than inflation-like expansion beyond years two or three. We thought this was conservative, and our technical-analysis process, flashed a bullish signal that prompted us to add the firm to our Best Ideas portfolio. Our subscribers were well-rewarded as Apple had run up to over $600 per share.
We don't think the valuation story behind Apple is done yet. We think the firm is worth over $800 per share, indicating significant upside potential. Please view the front page of our 16-page report on Apple below for more information.
Valuentum has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Netflix. Motley Fool newsletter services recommend Apple and Netflix. 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.