Avoiding Stocks With Massive Negatives

The YTD performance for the market has obviously been bad. Most investors I speak to are down for the year. Many of them are down massively. How could it be otherwise when the list of the worst-performing stocks includes names like…:

• Coinbase Global (COIN)
• Netflix (NFLX)
• Under Armour (UAA)
• AMC Entertainment (AMC)
• NVIDIA (NVDA)
• Tesla (TSLA)
• Meta (FB)
• General Motors (GM)
• Ford Motor (F)
• Rockwell Automation (ROK)
• Boeing (BA)

All of these companies have dropped more than 40% YTD. Coinbase is down as much as 74%, and Netflix is close to 70%. Can you imagine if you had a portfolio that consisted of companies such as this? In less than 6 months, you could have lost more than half of your entire portfolio value.

Ouch.

How many of these companies do I own in my personal portfolio?

The answer is easy – Zero

How many of these companies do I own in any portfolio?

Again, the answer is easy – Zero

That’s why my portfolio is looking more like this:

How do I avoid making decisions that result in drops of over 70% in a very short time on a portfolio-wide basis?

Quite simple.

I try to combine approaches of valuation, sector expertise, and conservative forecasts to make sure that portfolios I manage or run for myself, or as examples for others, don’t invest in companies that are either too high in risk or too high in valuation.

Can I guarantee the alpha? Of course, not – nobody could. But if you follow the strategy I espouse, you can be certain you’ll get the full wealth and advantage of the combined expertise of my, as well as the people I follow or talk to, focusing on getting the cheapest and most qualitative businesses out there.

I feel like I’m really harping on this point – but given how many private messages I’m getting and what they ask, I realize that most investors still haven’t come across the point that I’m trying to make here.

Value investing – what it is, and why it’s better

There are two main methods of investing that investors try to utilize in their approach. Value investing and growth investing.

In value investing, I try to find stocks/companies that appear to be trading for less than what we view their value to be. In short, I try to find stocks that we feel the market is underestimating.

Our belief, as value investors, is that the stock market overreacts both to negative and to positive news, and unfairly punishes as well as unfairly rewards stocks in the short term for either negative or positive news. These result in stock price movements that are disjointed from long-term fundamentals.

What this means, in essence, is that due to negative news, value can get stocks at a cheaper price than what they actually might be worth.

As value investors, we have a lot of great investors in our corner. This crowd involves Warren Buffett, Benjamin Graham, David Dodd, Charlie Munger, billionaire managers like Seth Klarman, and many others.

We don’t:

• Follow the herd
• Irrationally act in an either Buy/Sell manner without first doing the research
• Invest impulsively
• Buy “trend” stocks that are “hot” right now.
• Believe that markets are efficient
• Move based on biases, or anything other than market fundamentals and company fundamentals

As a value investor, I believe the notion of an efficient market hypothesis is downright ludicrous. I believe that every time we see a bubble or a massive crash, it’s a direct proof against this hypothesis, which says that stock prices reflect the underlying value of a company. I view this as false.

As a value investor, I’m more akin to a contrarian. When everyone else is selling, I’m usually the one who’s buying – and when everyone else is saying that a company is the best thing since sliced bread, I’m taking a step back and re-evaluating the fundamentals.

Value investing is the more time-intensive of the two methods. Estimating the intrinsic value of a stock and doing a proper forecast is a mix of science and expertise, as well as a bit of an art form. Some investors put no faith in future estimates of growth – while others focus on estimated cash flows and potentials. Investment gurus like Buffett focus very highly on looking at financial statements and valuation multiples in order to find mispriced stocks.

No matter your approach, your underlying logic as a value investor is almost identical.

I try to purchase assets for less than they are currently worth. I hold them, and I sell or trim them when the asset is at or above the value I assign to it.

There is zero instant gratification in this method. You will likely have to wait years for the realization of profits in most cases. The good news is that I focus mostly on assets or stocks that pay dividends, not just capital appreciation. Also, long-term cap gains are taxed far more favorably than short-term gains in most tax domiciles.

So, this is a strategy that favors long-term holding.

Why value investing works

Value investing works because the notion of an efficient market is false. We’ve all seen over the past few months that people invest irrationally and based on psychological bias. When a stock’s price rises, they buy. When it rises more, they buy more.

Why?

Because they develop a fear of missing out, they become caught in a cycle of believing that things will continue to go upward forever. The opposite is true too. Loss aversion can make you sell your stocks, without there really being a fundamental reason for doing so. Such investor behavior is so widespread that it affects the prices of individual stocks, exacerbating both upward and downward market movements and creating excessive moves in the market.

So, when the market reaches a near-ridiculous high level, it results in what we call a bubble.

That’s where we are today. Welcome to the bubble!

Bubbles are unsustainable, they pop, and this leads to a market crash. That’s exactly what we’re in the middle of right now. As I’m writing this, indexes have entered a bear market. This is what happened in early 2000, and it’s what’s starting to happen now.

I value-invest by thoroughly researching the companies I’m interested in. A good strategy, especially if we’re in a market like this, is to look at business fundamentals and look at how the company will grow earnings going forward.

• Will the company raise its prices for its services, products, or things like the rent for its properties?
• Will the company increase sales?
• Will the company decrease its expenses?
• Will the company become more profitable by selling assets/portions?

Study a company. Know the company. How will they be growing? The problem with most of these questions is that there are very few ways to actually determine good answers for these questions. That’s where company expertise comes in.

Invest in companies that sell either high-demand or necessary products or services. Make sure these companies have pricing power or some sort of moat.

I wouldn’t want to invest in any other way – especially not in this market.

Now, let’s look at some great examples of stocks that you can actually buy in this market.

Some excellent buys – at great value

You know me. I want investment-grade safety, high yield, superb upside based on earnings/cash flow growth as well as reversion, and good moats that act as safeties in a market like these.

I don’t get out of the bed for less than exactly this.

1. Simon Property Group (SPG)

A-rated credit, 6%+ yield, confirmed high demand, forecasted earnings stability, and growth based on rent escalation and very high demand.

Even if you just forecast this company’s future at a 10X p/FFO, which is well below its historical average of 13X, the returns are still double digits on an annual basis.

Again, this epitomizes what I view to be a cornerstone of value investing. We pick a quality company, that’s seen an upward adjustment in spite of recent price action, and we wait for that upside to eventually materialize. SPG has it all:

• A quality company with a leading portfolio
• Superb management team, led by an industry veteran
• Confirmed higher demand, despite supposed pressure in retail
• Well-covered, recently-raised dividend.
• Superb conservative upside based both on growth and reversal

I own almost 4.8% of my portfolio in SPG, and I’m willing to buy even more.

2. Realty Income Corporation (O)

Realty Income is another great company. It’s one of the world’s premier REITs, it has a monthly payout, it’s A-rated, superb management, and a solid upside. It’s not as conservative as we’ve seen in SPG, but we still have an upside based on rent escalation, volume growth, and new deals, even in this environment.

Realty Income would have to be valued at FFO multiples of below 13X to give us negative future returns here. But the company has traded closer to 20X, with only very short-term minute changes in historical valuation to its premium.

This means that the upside is still 14-17% annually on a conservative basis.

The company has almost the exact same conservative fundamentals and upsides, at least theoretically, as we see in Simon Property Group.

When people ask me what REITs they should buy, my answer is always simple.

I would buy SPG and O. Those are my main US REIT holdings. They have been for several years, and I’m open to expanding them even further.

3. AT&T (T), Verizon Communications (VZ), and Deutsche Telekom (OTCQX:DTEGY)

I love telcos. Their predictable, recession-proof cash flows, the way they can easily bump prices without much push-back from consumers given that their services are now necessary to normal life. Their massive moats and their overall market size.

Telcos are, simply put, a great way to place cash in today’s market. That’s why my combined positions in the above companies are nearly 7.5% collectively. With those three, you get exposure to nearly the entirety of big telco in the US, as well as some really appealing EU exposure to telecommunications.

VZ is at 9X P/E. T is at 9.27X. DTEGY is somewhat higher, at 13.8X. DTEGY has the lowest dividend – but if you read my articles on the company, you’ll see why I believe the company set to advance that dividend by perhaps doubling it in less than 4 years.

All of these businesses have a conservative annualized upside of no less than 17-26% based on a 10-15X P/E.

Not everyone likes telcos. They’re CapEx intensive, and with spectrum payments and infrastructure demands, it’s understandable why some are nervous about the company’s ability to push prices compared to the cost increases – but I firmly believe that these companies will retain their margins, as evidenced by Verizon’s recent price bump.

People can underestimate Telco all they want. This is what contrarian value investing is about. I believe that numbers are very clear in that things aren’t going down – and I believe telco to be good investments to safeguard your capital for the coming few years.

4. Manulife (MFC)

Cheap quality, dear readers. Cheap quality – that’s the name of the game. Manulife is exactly that. Financials are going to be enjoying significant upsides due to the changes in net interest income due to rates. Companies like MFC are set to grow earnings due to premium growth. Manulife typically tends to trade at ranges of 7-9X. It currently trades at 6.96X – pretty close to a trough-sort of valuation right here. The company is also expected to increase earnings in the double digits for the next 3 years on average, even after guidance.

The 25% annualized forecasted upside is pretty solid.

But even if you get multiples of only say, 6-7X, that’s still an upside of 10-15%.

That’s a good upside, dear readers.

Oh, you’ll have people argue that those upsides aren’t valid anymore in this market, because of rates. Or bubbles, or declining values. I disagree. MFC will enjoy advantages due to rates, and this business is cheap enough to make it through any bubble coming out on top – that’s my view.

But the next one can be said to be even more conservative.

5. BlackRock (BLK)

Ever heard of the largest asset manager on earth?

Yeah, I thought you might.

The last time this company dipped below 16X P/E, missed out on the cheap BlackRock, and I kicked myself for years. I’m not making that mistake again. BlackRock is an AA-rated reflection of the market. Assuming that we’ll turn around eventually, BlackRock will turn around as well.

The upside for this insanely conservative business is no less than 23.5% to the company’s typical premium of 20X – and I’ll argue against anyone who considers this company not to have a through-cyclic sort of safety and fundamentals. The notion that BlackRock does not is ridiculous to me.

Even if you don’t believe the company is only worth 14-15X P/E, you’re still making more than inflation on these forecasts, about 9% per year annualized. Even on that low-ball forecast, I’d still consider this business a solid investment with its fundamentals. Because it has what we’re looking for as value investors.

• A quality company with a leading portfolio
• Superb management team, led by an industry veteran
• Confirmed higher demand, despite supposed pressure in retail
• Well-covered, recently-raised dividend.
• Superb conservative upside based both on growth and reversal

Risks

Of course, not everything is green pastures with a value approach. Let me show you the downside of my “secret sauce”.

1. Overpaying for stocks

This is obviously the main risk. Overpaying or misestimating upsides means that you pay more for a company than the company can realistically deliver, due to actual RoR. This means your money will not grow at the same pace as you expect it to. It can even lead to negative returns – or horror of horrors, loss of capital if your investment goes into bankruptcy.

This hasn’t happened to any of my investments – but it can if one is not careful.

2. Value traps

A stock that appears to be cheap, due to massive declines, can still fall further. The illusion that a stock may have hit bottom because of a decline of X% is dangerous unless a company is well understood. Even then, it’s not a guarantee.

This kind of stock is what is known as a “value trap”, where the stock appears to be cheap because of low multiples of P/E or P/B, or even CF. Investors looking for a bargain buy into such a company only to never see the stock price improve again. You may ignore rising competition, declining growth, increased debt, cyclicality, poor management, or any one of such risks.

These are the two main risks I see, and the two main risks I try to avoid in every decision I make. As of right now, most of the time, I manage this. There are also limitations in that you can blind yourself to growth opportunities that do not conform to these rules of investing – which can become detrimental to returns on a broader basis, as we’ve seen with the recent 3 years of NASDAQ outperformance.

Wrapping up

This, to me, my approach is the only choice available in a market like this.

Everything else is off the board. If it isn’t quality, and it isn’t undervalued, I’m not interested in the least. If it doesn’t have a superb, well-covered dividend and a good upside, I’m likely to skim it over.

Because I believe the market will get a lot worse before it gets any better.

The best way to arm yourself against this sort of market is with expertise. With knowledge. By having good people, and good investors safeguarding your capital and your investments.

I believe that in my articles, I provide you with what is a quality analysis and upside, quality businesses checked on most levels that matter to investors.

Obviously, I can’t guarantee positive returns.

What I can guarantee is that you will be investing in companies I consider to be among the most qualitative out there.

For me, this has driven positive, market-beating returns for years on end.

It could do the same for you.