Like a perfect golf swing, successful value investing seems so simple yet it eludes so many of us. Most investors love the idea of buying a dollar for fifty cents, so why is it so hard to do? Well, like a perfect golf swing, to spot true value you just need to adopt a few tips.
Here’s an important tip (along with some stock picks) that will help keep your value swing profitable: Understanding panic, negativity and cycles is the key to a great opening drive.
“Rule number one: most things will prove to be cyclical. Rule number two: some of the greatest opportunities for gain and loss come when people forget rule number one.”
The very best value gains are born from unjustly emotional (negative) sentiment about a stock or sector. Having a trained eye–not blind faith—for when this sentiment attacks a truly great company is the key to finding real value.
The cycle of negative sentiment usually works like this:
1). Media/analyst depression. This comes from one of the following: a). a fantastic stocks growth plateaus or b). panicky headlines swamp an otherwise great company.
2). The market starts to write a story. Example: “XYZ catalyst has happened so ABC great company must be near death.”
3). The market overshoots the mark. Real risks are largely over-exaggerated based on opinions.
Two or three quarters pass…
4). The market takes a Xanax. Risk is re-calculated. Sentiment goes from free-fall negativity to stabilization.
5). The intrinsic value of the company acts like a magnet and pulls the stock price back up.
The exact same cycle occurs with overly positive sentiment and “bubbles.”
So here’s a tip: finding value is as simple as finding profitable companies at about “stage three.”
What companies does the market misunderstand right now? Here are three stocks arriving at stage three:
Coach, Inc. (NYSE:COH) and Apple, Inc. (NASDAQ:AAPL) are both experiencing the same phenomena right now.
Coach, Inc. (NYSE:COH) is coming off of a year that saw record earnings, wonderful growth in earnings per share, and a staggering return on equity (over 50%). Apple, Inc. (NASDAQ:AAPL)’s last quarter saw 18% growth in revenue, 7% growth in earnings, and cash reserves on their way to a staggering $160 billion.
There is competition though. Coach, Inc. (NYSE:COH) isn’t growing as quickly as newcomer Michael Kors Holdings Ltd (NYSE:KORS), and Apple is fending off advances from the Samsung and Google “tag-team.” So it’s only natural that the S&P 500 has lapped them both, right?
My opinion: record performance + depressed market sentiment= $$$!
These stocks are experiencing the same negative sentiment right now–they’re not “next.”
Because Coach’s story isn’t “new,” the market will focus on negatives like Coach’s exposure to European business while ignoring the fact that the company is growing over 50% in key growth areas (Men’s bags/accessories, china, etc).
Is Kors that different than Coach, Inc. (NYSE:COH)? Even if Kors hits its lofty expectations over the next two years (EPS of $1.86 and $2.45) something as simple as “weak guidance” will cause that lofty valuation to slip. Coach would benefit greatly if Kors returns to earth, and Coach also has a catalyst in new management. The positive sentiment is due to return to Coach.
Likewise, the market (at some point) will turn positive on Apple, Inc. (NASDAQ:AAPL). Tech investors love “new” things. Apple has multiple catalysts in the form of new products possibilities this year. They include two new phones (an iPhone upgrade and a cheaper iPhone), a TV market, and a “smart watch.”
When new products come, the market will realize Apple’s been using its huge cash hoard wisely already—on R&D!
In short: Apple, Inc. (NASDAQ:AAPL), Coach, Kors–all great companies. Sooner or later, Mr. Market will see that they’re all winners—it doesn’t have to be “either, or.”