Investor Want a KracKeR? (KKR,LMNR,HAIN,QQQ,TREE)
We’ve long admired legendary investor David Dreman, author of the ‘Contrarian Investment Strategies’ series of books. His approach to value investing was a tremendous help to us when we began in the business some 25 years ago. And even though the days of pure value investing are likely behind us for good, once a while a good opportunity does pop up, and we try to avail ourselves of it.
What was the essence of Dreman’s approach?
Contrarian investing for Dreman was a matter of finding desperately battered stocks and buying them for the long haul, say, three years or more. Three measures, for him, marked a security that was ripe for purchase: a low price to book ratio, low price to earnings and a healthy dividend yield.
When those three metrics were in play, the stock was considered good value, and Dreman bought.
But investing trends change and markets don’t always avail themselves of the systematic and disciplined approach that marked the last generation’s methodology. Today, stocks will rise – even soar – with little if any of what Dreman sought before he bought.
Today, it’s all about momentum and cash flows. What’s ‘in the news’ and what marketing teams can drum up and create a stir over is what drives equities these days.
And Wall Street is more than happy to play along, expanding multiples and making what would have been for folks like Dreman a leprosy, something rather enchanting – even exotic.
Consider a few examples.
Start with Amazon (NASDAQ:AMZN), a company with an admittedly dominant position in the retail sphere and a robust growth curve. But come on, guys. AMZN has a Price/Earnings ratio of 249! (Not a typo.) It offers investors no yield whatsoever and trades at a surreal 24x book value!
Yet it keeps going up.
Then there’s Netflix (NASDAQ:NFLX), another dominant player in the online sales race. That stock sports a twelve month trailing earnings multiple of 196 (!), also pays absolutely nothing in dividends and trades at a wildly preposterous 31x book.
What would dear old Mr. Dreman have to say about investors willing to pay 31x the breakup value of a company?
Not only would he avoid looking at these companies, he would more likely use their numbers as a natural mucolytic. Why spend money, after all, on an expectorant when the same effect can be induced by gazing at an earnings statement.
All that aside, there are still several companies that qualify to us Normans as Dremanesque value plays, while, at the same time, satisfying our need for proper technical supports, as well.
And we’re going to have a look at two of them.
But before we do, let’s have a quick glance backward at three trades that need your immediate attention.
The first was launched on September 5th in a letter called Organic Investing. There, we urged you to purchase 100 LMNR shares at the market and sell 100 shares of HAIN at the market for a total credit of $1749.
Today, LMNR sells for $23.05 and HAIN for $37.52. Sell off the former and buy back the latter for a debit of $1447. Total gain on the trade is $302 per lot traded – on nothing spent. Adjusted for minimal commissions gives you a return of 1913% in just seven weeks.
Next was our trade of two weeks ago. The letter was called Melancholy Bull and recommended you sell the QQQ December 15th 145 PUT for $2.29 and buy the QQQ December 15th 150 CALL for $2.16. Total credit on the trade was $0.13.
Today the PUT goes for $1.67 and the CALL for $2.22. Buy back the former and sell off the latter and you net $0.68 on absolutely nothing laid down. Adjusted for minimal commissions gives you a return of 353% in two weeks.
Finally, last week’s missive was called Stocks that Grow to the Sky. In it, we suggested you buy the TREE December 21st (2018) 185 PUT for $24.40 and sell the TREE December 21st (2018) 300 CALL for $25.80. Total credit was $1.40.
The PUT now sells for $26.50 and the CALL for $22.30. Sell the former and buy back the latter and you net a fat $5.60 in just a week on nothing spent!
That’s 3633%! Or 188,900% annualized.
Two Value Stocks for the Trump Era
Back to the subject at hand…
First, let’s name names. The companies we like are investment house KKR & Co. (NYSE:KKR) and insurance operator Old Republic International (NYSE:ORI).
And how exactly do their fundamentals stack up?
First, KKR, trading at $20.40, has a market cap of $16.6 billion, a price/earnings ratio of 8.6x trailing profits, a price to book ratio of 1.53, and a dividend yield of 3.3%.
A good enough set of measurements for any era.
ORI ($19.54) sports a market cap of $5.19 billion, trades at a multiple of 12.3x last year’s earnings, 1.10x book value, and pays an annual 3.89% to shareholders of record.
There are others, to be sure, that possess the statistical talent to file in alongside the above named duo, but they lack the proper technical structure, and without that, we have little confidence that they have any near- to mid-term upside.
In short, they have strong paper fundamentals because they’re stocks that have lost ground very quickly, and appear to be on course to continuing lower.
Without belaboring the point, these are likely companies that will very shortly be announcing dividend cuts, depressing earnings guidance and possibly the selloff of important assets.
If not worse.
Dreman’s calculus, we believe, requires a tactical, ‘second sift’ in order to exclude those firms that have pretty numbers simply because they’ve fallen out of favor and lost a great deal of price, while gaining a great deal of ‘value’ at the same time.
Some understanding of the company’s particular circumstances and their competitive position vis-à-vis the rest of the industry is obviously also in order.
That said, let’s now have a look now at KKR’s chart for the last two years.
As you can see, the company’s shares have been moving steadily higher since July of 2016 and have yet to push above RSI 80 (in green), a development that would ring an alarm bell for all KKR bulls.
Until we hear it, we’re dedicated.
- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
Wall Street Elite recommends you buy the KKR June 15th 21 CALL for $1.25 and sell the KKR June 15th 21 PUT for $1.90. Total credit on the trade is $0.65.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
With kind regards,
Hugh L. O’Haynew