With the constant bull market of the preceding weeks, nearly any investor could have been profitable. Outperformance, however, was primarily achieved by those with intelligently selected stocks. As the market steadily grew, stocks with superior reward-to-risk ratios generally appreciated more and the outperformance was realized. Interestingly, when the stocks that should outperform do, the opportunities for outperformance diminish as the outliers normalize.
There is a theoretical point at which all stocks would trade with perfectly synchronized risk and reward such that any allocation would be approximately equally strong. While I do not think the market got there, it was certainly getting close. The range of valuations had tightened up and correlated appropriately with risk. The market approaching efficiency could be considered good, but it is also troubling for those of us who seek to outperform. Thankfully, the market behavior on May 22, 2013, May 23, 2013, and May 23, 2013, has reinvigorated opportunities.
This market shakeup affected certain stocks disproportionately and seemingly arbitrarily. Stocks with similar risk profiles and investment characteristics moved in opposite directions. Risk is no longer closely correlated with reward. There are once again outliers with a severe imbalance. Certain stocks have both a big upside and a minimal downside, while others suffer from high risk with minimal reward. This situation exacerbates the impetus for analysis and generates the following thesis: Investors who can correctly identify the outliers and take appropriate action should substantially outperform those who do not.
While the above statement holds true for any market situation, the magnitude of potential outperformance is greater when the market is less efficient. Our analysis has identified five tremendous opportunities in which the upside substantially and disproportionally outweighs the risk.
1. Long Position in CapLease (LSE)
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CapLease has dropped over 8% with no fundamental change. It was a value triple net play before the drop, and it has become a much deeper value.
2. Long Position in Ashford Hospitality Trust (AHT)
Ashford dropped along with the market, despite the fact that new fundamental strength was revealed at the recent investor day conference. It now trades at a price to FFO of 7.6, which is less than half of that of the broader REIT market.
3. Short Position in AmREIT (AMRE)
AMRE managed to hold its ground while the rest of the market crashed. This stock was already overvalued on a relative basis and has become a true outlier. It recently had a large number of untradable shares get converted to tradable and many of its investors are not yet aware they can sell. With a price to FFO over 19 and a near-term negative catalyst of pent-up liquidity demand, AMRE makes an interesting short candidate.
4. Long Position in Medical Properties Trust (MPW)
Medical Properties Trust was already underperforming the rest of the healthcare REITs and becoming a relative value. The sharp decline in its market price this week accelerated the process, making MPW a true value and an excellent source for exposure to a strong sector.
5. Long Position in Brandywine Realty (BDN)
Brandywine is among the more stable office REITs, yet it trades at the lowest FFO multiple of only 10.5. In my opinion, the drop has created value so deep that it compels consideration.
The market's erratic behavior this week has generated many opportunities. The five mentioned above are, in my opinion, among the best. As the brief descriptions of each opportunity provided above is not sufficient to constitute action, I intend to write full focus articles on each opportunity that will contain far deeper analysis. Stay tuned for the detailed buy and sell theses.
Disclosure: 2nd Market Capital and its affiliated accounts are long LSE, AHT, BDN, and MPW. I am personally long LSE and AHT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.