Bill Rempel on Potential Buying Candidates - Part II
(Guest Commentary by Bill Rempel August 16, 2007)
Dear Subscribers and Readers,
On the third Wednesday of every month, we usually bring in Mr. Rick Konrad Rick (author of the excellent investment blog Value Discipline, founder of Value Architects Asset Management) as our guest commentator. However, he is unavailable for a guest commentary this week for personal reasons but will instead write us a guest commentary next week. Trust me, you will not be disappointed.
In Rick's absence, I have again brought in our other regular guest commentator, Bill Rempel (author of the excellent market blog at: http://www.billakanodoodahs.com/) for an update of his commentary and analysis from two weeks ago. In his commentary from two weeks ago (Bill Rempel on Potential Buying Candidates), Bill discussed his methodologies for screening for tradable longs to buy into after the latest correction is over. While some may believe that the latest correction still have further to go (I personally still believe we're in a correction within a cyclical bull market, until or unless I see sufficient evidence of earnings power deterioration of U.S. large caps going forward) I personally believe Bill's methodologies are very good and original and can be used to your profit if implemented in a disciplined way. Bill also gave sufficient background and education so you can do these screens on your own anytime you want.
Before we dig deep into Bill's latest guest commentary, I want to update our readers on the latest readings of our global overbought/oversold model that I had initially discussed in the same commentary from two weeks ago. In that commentary, I stated that the purpose of this model is to help our subscribers keep track of all the international market indices and new international ETF products being developed out there today. Given the market carnage of the last two weeks, it is probably a good time to do an update even though the end of the month is not upon us yet (the model uses MSCI monthly data).
Again, the inner workings of this global overbought/oversold model are rather simplistic. For each country or region, we first compute the month-end % deviation from its 3, 6, 12, 24, and 36-month averages. Each of these % deviations are than ranked (on a percentile basis) against all the monthly deviations (against itself only, not deviations for other countries or regions) stretching back to December 1998. This way, we are comparing apples to apples and can control for country or region-specific volatility. Following is our Global Overbought/Oversold Model as of the end of July, 2007 (which has been shown previously):
All the percentile rankings highlighted in yellow in the above table represent rankings below the 15th percentile which is consistent with a reading that is at more than one standard deviation below the mean (note that this is a true standard deviation calculation based on historical data and does not assume that returns are normally distributed). That is, relative to the historical % deviations of the same country or region, the current % deviation is more oversold than 85% of its readings going back to December 1998. As you can see aside from four selected regions/countries that made the cut in one form or another (i.e. North America, Austria, Ireland, and Jordan) the global stock market was still not that oversold at the end of July even on a three-month basis:
Fast forward now to August 15, 2007:
Not surprisingly, there are now many more cells highlighted in yellow after the sell-off over the last two weeks with the bulk of these being in the developed countries, and Latin America. Over the last month, the only investable countries (both developed and emerging) that were up are Jordan (+0.3%), Venezuela (+0.4%), and Morocco (+2.7%). Surprisingly, many EM countries are still exhibiting relative strength although the readings of this model do not take into account the latest rout in Asia as I am typing this.
On both a six-month and 12-month basis, however, most (if not virtually all) countries are still not particularly oversold. As such, I am still not expecting a major bottom at this point, unless the S&P 500 declines another 5% to 10% over the next week or so. Again, please note that the above model is a price-only model and therefore doesn't take into account valuations and also does not work too well for countries that are experiencing secular changes, such as China (e.g. subscribers would have been dismayed if they had shorted China just because this indicator says it is overbought). It also doesn't work well for timing tops in the stock market but that's just the general nature of most overbought/oversold indicators. One thing that will come in very handy, however, is the model's ability to evaluate oversold countries/regions and to provide initial ideas on the long side. Going forward, we will continue to update this on a monthly basis and post it onto our commentaries.
Now, let us get on with our guest commentary. For those who had wanted to learn more about individual stocks and the art of stock selection, it is again time to see what one of our regular guest commentators, Bill Rempel, has to say about his favorite picks. Bill is a prolific writing on the stock market and individual stocks and is the author of a very active market blog at: http://www.billakanodoodahs.com/
In this commentary, Bill is going to update an analysis that he produced for us two weeks ago showing us his methodologies for screening for tradable longs to buy into after the latest correction is over. Bill also gives sufficient background and education so you can do these screens on your own anytime you want. Without further ado, following is biography of Bill:
Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see Bill Rempel on Potential Buying Candidates for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.
Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."
Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice. Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.
Every correction brings opportunities, and this one is no exception. Right now, the S&P 500 is down about 10% from the highs, as opposed to the 6% or so that it was when I wrote the first installment on this theme, so it should be fun to look at lists of ideas from various vantage points, that help create a "shopping list" of individual stocks that might be worth buying soon.
The first obvious area to look is "value stocks." In many cases, companies with otherwise fine fundamentals can become especially cheap after market action like we've just experienced. The scan here is a play on my traditional value screener.
Exchange: Non OTC,
Price Perf. (Last 52 Wk): Less than or Equal to 0%,
P/E (TTM Intraday): Less than or Equal to 12,
Price/Book Ratio: Less than or Equal to 2,
Book Value Growth (5-Yr Avg.): Greater than or Equal to 5%,
Ret. on Assets (TTM): Greater than or Equal to 5%,
Debt to Capital: Less than or Equal to 67%
I will list the stocks in alphabetical order by ticker symbol to avoid bias. My approach would be to look at each company for the following: a pattern of operating cash flow exceeding net income over time, and a lack of dramatic positive cash flow from financing operations. Companies that pass those tests would then be candidates for a proxy and 10K read, followed by a possible long-term "buy and hold" value approach. This is a much longer list than it was two weeks ago!
A more aggressive fundamental approach is buying extreme earnings and revenue growth "on the cheap." I prefer looking at historical growth rather than projected growth, because often the opportunities that are best are those that aren't followed by the analysts.
Exchange: Non OTC,
P/E (TTM Intraday): Less than or Equal to 20,
EPS Gwth. (Last Qtr. vs. Same Qtr. Prior Yr): Greater than or Equal to 20%,
EPS Growth (TTM vs. Prior TTM): Greater than or Equal to 20%,
EPS Growth: 3-Yr Hist.: Greater than or Equal to 20%,
Rev. Gwth. (Last Qtr. vs. Same Qtr. Prior Yr): Greater than or Equal to 20%,
Rev. Growth (Last TTM vs. Prior TTM): Greater than or Equal to 20%
This scan, "as is," gives 85 names. They could potentially be placed in a watchlist and positions opened on those that began to move; when I've used this scanner, I prefer to focus on those companies showing earnings and revenue acceleration, rather than just growth. In other words, the QOQ growth should be higher than the YOY growth, which should be higher than the long-term average. The sort here will float those with acceleration to the top of the list, and otherwise will be alphabetical by ticker. Those twelve with acceleration will be in italics. These will often be names that have been leaders in the prior market surge, and I would be watching to see if they move before positions are opened.
One popular school of thought is that prior leaders may resume their roles after a correction. I don't know if I buy this; there is a good chance that some, if not most, of the prior leaders are done for, especially if the corrective action represented a change in meme. However, if the correction was caused less by a rethinking of macro phenomena and more by panic (a.k.a. "sub slime") or other consideration (a.k.a. "carry trade"), then maybe many of these prior leaders will take off again. I think many of these names might be worth keeping an eye on.
Let's just say that, for purpose of argument, this correction started on June 1, 2007. As of that date, there were 512 stocks that had doubled in the previous 10 months (210 trading days). That's just a few too many to put on a watchlist. However, I can narrow this down by doing two things: tightening up on the market cap (higher) and loosening up the growth amount to generate however many stocks I want. For example, if I were to consider only stocks with market cap of $1 billion or more to be capable of "leadership," then I would have found only 87 doublers, some of whom are listed above in the "growth at a reasonable price" scan. This list hasn't changed since the first time it was published.
The final school of thought I want to touch on for my possible shopping list is a group of major U.S. stocks that have held up the best during the correction. For example, a measure of breadth used to detect a bottom is a very low percentage of S&P 500 stocks trading above their 50-day exponential moving average of price. This measure is now at a post-2002 low of 38!!!
There are, of course, other strategies for finding the leaders out of the correction, including sector strategies or momentum strategies based on indicators like the PPO (a percentage version of MACD), and these are, in my opinion, more appropriate for an ETF strategy than for individual stock selection. It's also important to note that the current correction is deep and long enough so that very few of these ETFs have positive PPO Signal lines!
It may or may not be the right time to buy; but when it is time to buy, these strategies present a defined method for paring a shopping list for what to buy.