I often analyze stocks like I analyze people. For whatever reason, some individuals have very tolerant and stable personalities, while other personalities are quite volatile. Some girls seem to constantly fall for bad boys, while others like geeks. And even short, fat, bald guys.....well, yeah... sorry only your mom likes you! Ha! The point is that there are many different types of people with wide varieties of traits. Another way to describe individuals is by their shape. Everyone has a range..ahem..(you see by the end of this blog I will have offended everyone!) that is often categorized by the Height-Weight-Proportional chart. Basically if you are a certain height, there is a certain body mass that the medical community would deem as healthy or normal. Some people are above the range, while others are under this range. Stocks also have a HWP relationship as well. While the media wants you to believe that this relationship is overly complicated, it is really astonishingly quite straight forward. Before moving on, I just want to give a shout-out to Fast Graphs who is supplying me with these visuals.
I've purposely removed any identification to these price charts to not confuse this relationship between price and value. The name of the company can influence individual buying and selling behavior so I have removed any identifying features. The orange line is my estimate of fair value for these businesses. The chief influencer to the value line is growth, but also sustainability and visibility are ingredients as well. As you can see in the chart above, this company went through a period in which the price was under its HWP range and over-time, for what ever reason, was bid up in price to a point in which no willing buyers were accepting of offers and began to bid the price lower. Fortunately for this business, operations have been able to grow cash flow and at some point in the future, the companies share price will represent a nice discount to a future HWP range. It is just not there yet. So all we can do is wait. Let's take a look at out second example below.
This stock is quite poplar as you can see by the rapidly rising black line (share price). While yes, it was an undervalued business from 2012 to 2015, some catalyst occurred in 2015 that caused a upward trajectory to its fair value. Remember the chief driver for all stocks is growth in earnings. And just looking at the orange line, you can see there was a large ramp up in value. Like all good narratives on Wall Street, this one is probably played out. Can the share price continue to rise? It sure can! My estimate of fair value could turn out to be too conservative. I place little concern on this idea, but it is definitely a possibility. However, operating in stocks is NOT a possibility business, it is a probability business. At this point, if the share price continues to rise, it is simply pulling forward more years of earnings stream into today's price quote. At some price, just like in the example above, there will be no buyers and sellers will begin to bid their shares at lower prices. And so the cycle begins.
Let's look at the last example below.
So here were are looking at a very different situation than the previous example. The current quote is not only substantially below the current HWP range, but is also dramatically underestimating the current growth potential for this business. A couple of observations to think about. First, notice the share price. It is over $100 per share. This isn't some lottery ticket company. It is a substantial business. The second is that we are dealing with the future and the future is...well...unknowable. So, even if my growth estimates are too aggressive, I've built in a lot of failure to this estimate. Again, this is a probability game. I look at this company as heads I win big and tails I win a little. If you place your energy into companies with similar risk/return profiles, I believe good things are going to happen! Every stock has a cycle. There is a time to pant and a time to sow. Once you understand the cycle, you don't need to worry about the stories being peddled by the media or Wall Street. The cycle is our hacksaw to the pinocchios on Broad and Wall.
Happy Returns,
P. Franklin, Jr.
May 26th, 2017
* Disclosure: Franklin Trend Management, LLC. currently owns shares in mystery company number 3.
All opinions and estimates included in this communication constitute the author’s judgment as of the date of this report and are subject to change without notice. This communication is for informational purposes only. It is not intended as an offer or solicitation with respect to the purchase or sale of any security. This information is subject to change at any time, based on market and other conditions. Any forward looking statements are just opinions – not a statement of fact.
Investing may involve risk including loss of principal. Investment returns, particularly over shorter time periods are highly dependent on trends in the various investment markets. Past performance does not guarantee future results.