| My Top 2 Picks
From a Legendary Value Investor | Successful value investors often work in relative obscurity, delivering steady, market-beating returns over decades.
Jeremy Grantham is an investor that has been following a value approach to the markets since at least 1977, when he co-founded global investment management firm GMO. Over the years, GMO has grown to manage more than $100 billion in assets but is still relatively unknown.
Grantham applies a classic Graham and Dodd value approach to the markets. Benjamin Graham and David Dodd wrote the original textbook on value investing, "Security Analysis," in the 1930s. Warren Buffett would later study under Graham. And while countless investors have read the original and revised editions of Security Analysis, only a few have mastered the concepts. The very best value investors, a group that includes Buffett and Grantham, add a unique perspective to their study. In the case of Grantham, his success is at least partly due to his ability to spot bubbles. He may know more about bubbles than any other investor. In a recent letter to investors, Grantham wrote, "We have studied more or less all assets for as long as we can find data and we have found a remarkable total of 330 'bubbles,' 36 of which we call 'major, important bubbles,' which we define as 2-standard-deviation events."
As an example of what Grantham looks for in a bubble, we can consider the S&P 500 index. According to Standard & Poor's, the price-to-earnings (P/E) ratio of the stocks in the index is 15.31. Using quarterly data back to 1988, the average P/E ratio has been 18.76.
Standard deviations can be used to measure how much the data varies from average. A high standard deviation will indicate the data often moves far above or below average. A smaller standard deviation will show that the data tends to stay closer to the average. In the case of P/E ratios on the S&P 500 index, the standard deviation since 1988 has been 4.44.
A bubble develops when the price of an asset is unreasonably overvalued. Like Grantham, many analysts consider values that are more than 2 standard deviations greater than average to be bubbles. We would expect values to be this high less than 2.3% of the time. P/E ratios on the S&P 500 index greater than 27.64 would signal a bubble.
Grantham used his knowledge of bubbles to deliver gains to his investors when the Internet bubble was bursting in 2000 and 2001. He also lost less than the market in 2008 as the housing bubble burst.
In addition to studying bubbles, GMO develops forecasts for asset classes based on their studies of long-term value. Right now, Grantham is most bullish on stocks in emerging markets, which he expects to provide average annual gains of 6.8%, after inflation, over the next seven years. In the U.S., Grantham's firm sees average annual losses of 2.1% in large-cap stocks and 3.5% in small-cap stocks over the next seven years.
In studying Grantham and other great investors, I learned that the biggest stock market winners have solid fundamentals and strong technicals. I combined these factors into a model that finds market-leading stocks with the fastest growth in cash flow. When applying this system to Grantham's stocks, two buys jumped out.
Given his outlook that emerging markets will provide the largest gains in the long term, it is not surprising to see that two of his largest holdings are in emerging markets. It might be surprising to see an Internet company on the list, but that shows Grantham invests in value no matter what sector he finds it in.
Yandex (NASDAQ: YNDX) is Russia's largest search engine with about 60% of the market. Over the past five years, YNDX has reported average sales growth of 46.6% and an average increase of 39.5% in earnings per share (EPS). Free cash flow turned positive in 2008 and has grown from $0.15 a share to $0.74, an average growth rate of 37.6% a year.
In 2012, YNDX reported EPS of $0.82 and is expected to earn $1.12 in 2013. In 2014, analysts expect EPS of $1.43. After that, analysts expect EPS growth to average 29.5% a year in the next five years. Using 2014 estimated earnings, the stock trades at a P/E ratio of 24.
The PEG ratio compares the P/E ratio to the expected EPS growth rate, and YNDX has a PEG ratio of 0.81. The PEG ratio should be 1 for a stock that is fairly valued. This measure shows that YNDX is undervalued.
Copa Holdings (NYSE: CPA) is also undervalued with a PEG ratio of 0.53. Copa Holdings provides airline passenger and cargo services within Colombia and international flights from various cities in Colombia to Panama, Venezuela, Ecuador, Mexico, Cuba, Guatemala and Costa Rica.
Over the past five years, sales growth has averaged 17% a year, EPS grew an average of 14.7% a year, and free cash flow growth averaged 30.1% a year. Analysts expect earnings growth of 26.3% a year on average for the next five years. Based on 2014 EPS estimates, CPA could be worth more than $300 a share, more than double its recent price.
CPA has been profitable every year since 2006, including the global recession years of 2008 and 2009, when large U.S. airlines like United Continental Holdings (NYSE: UAL) and Delta Air Lines (NYSE: DAL) reported large losses.
Grantham has found winning stocks in the past, and equally important, he has avoided many of the large losses of the past. Most investors would not hunt for value in Russia and Colombia, but Grantham knows that successful investing requires hard work. He now holds YNDX and CPA, stocks which my system also highlights as potential winners.
My latest research shows that following market gurus like Grantham is one of the best ways to make money in the stock market. And Grantham is just one of the 20 investing gurus I follow.
But it's not as simple as looking at their portfolio and buying what they hold. Timing matters.
I've come out with a new free report that helps you understand exactly how you can beat the best gurus in the country at their own game. To get access to the free report, "How to Outperform Soros, Icahn... or Even Buffett," click here.
| Dr. Melvin Pasternak's Trades & Updates | | Company (symbol) | Trade Type | Buy/Sell Date | Buy/Sell Price | Stop-Loss | Current Price | Total Return | | SPDR High Yield Bond ETF (NYSE: JNK) | Long | 01/30/12 | $39.94 | $34.98 | $39.37 | -1.4% | | Procter & Gamble (NYSE: PG) | Long | 03/04/13 | $76.25 | $70.24 | $77.15 | 1.2% | | Coca-Cola (NYSE: KO) | Long | 04/08/13 | $40.06 | $37.49 | $38.35 | -4.3% | | Waste Connections (NYSE: WCN) | Long | 07/08/13 | $42.22 | $38.12 | $42.28 | 0.1% | | Beazer Homes USA (NYSE: BZH) | Long | 07/08/13 | $17.55 | $14.92 | $17.02 | -3.0% | | View all closed trades here. Stock prices in this issue are as of the close of trading on September 6. | | SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK) dropped modestly over the week. The fund is currently approaching resistance at the rising 50-day moving average. The middle Bollinger Band acts as support slightly below that. Daily RSI is testing the key 50 juncture. Daily MACD remains on a buy signal. I purchased the fund at $39.94. I'm currently marginally down on the trade. My stop-loss of $34.98 and target of $48.01 remain.
Procter & Gamble (NYSE: PG) slid slightly over the shortened holiday week, despite news the consumer goods company will release a cheaper version of its Tide liquid soap to attract budget-conscious shoppers. The stock is currently straddled between support at the lower Bollinger Band and resistance at the 150-day moving average. Daily RSI is holding just above the oversold 30 level. I purchased shares at $76.25. I'm currently up marginally on the trade. My stop-loss of $70.24 and target of $89.83 hold.
Coca-Cola (NYSE: KO) had a choppy trading week, but closed the week higher after reaffirming upbeat guidance for the 2013 fiscal year. Management anticipates earnings will come in between $2.45 to $2.50. Net sales are expected to grow at a low single-digit rate. The beverage company's stock is currently approaching resistance at the middle Bollinger Band. Daily RSI is approaching the key 50 juncture. Daily MACD and Stochastics have just flashed buy signals. So far, I'm down about 4% on the trade. I purchased shares at $40.06. My target of $44.30 and stop-loss of $37.49 remain.
Waste Connections (NYSE: WCN) slid slightly over the week. Shares of the waste management company are currently approaching resistance at the 50-day moving average. The lower Bollinger Band intersects slightly below, acting as support. Daily RSI is creeping up to the key 50 juncture. Daily stochastics is on a fresh buy signal. I purchased shares at $42.22. I'm currently about breakeven. My stop-loss of $38.12 and target of $48.95 hold.
Beazer Homes USA (NYSE: BZH) increased slightly this week, following news Fitch reaffirmed their B- credit rating on the homebuilder. Shares of the homebuilder are currently approaching resistance at the 50-day moving average. The middle Bollinger Band intersects slightly below, serving as support. Daily RSI is clinging to the key 50 juncture and holding flat. Daily MACD remains on a weak buy signal. So far, I'm down 3% on the trade. I purchased shares at $17.55. My stop-loss of $14.92 and target of $23.29 remain.
-- Dr. Melvin Pasternak
Co-Editor, Trade of the Week
To read my most recent article, Once-Popular Teen Retailer Looks Set to Take a Double-Digit Dive, visit ProfitableTrading.com. | Disclosure: None.
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