I'm not sure if anyone caught the cover of Bloomberg Markets this month, but splashed right across the front is "Stocks Billionaires Like." I understand the premise - Billionaires have access to information and opportunities that presumably made them billionaires (other "opportunities" include personal jets, supermodels, and football franchises). However, as an investor I do not have access to these things.
The point is, these guys can make large bets on certain stocks, and bend the circumstances around that stock to make their investment profitable. An example of this is Carl Icahn's investment in NAV earlier this week. But for the rest of us, we can't fix the issues that plague a company and then be the first to jump ship when the stock is spiking. We need to reduce risk, control exposure, and hedge our holdings.
To that end, I have created a portfolio that combines the concepts of opportunity buying (that we're all capable of) with portfolio optimization. Below is the methodology and analysis:
- Stock price greater than $5
- Valuations between $50M - $2B
- Sectors: Healthcare / technology / services with an emphasis on healthcare
- Volume: Greater than 10k
- Insider trades in excess of 5%
- Marginal upward movement or flat movement in terms of stock value (we want to avoid scenarios where insiders use their purchases as a signal of bottom, or that a recent increase in value is justified).
Now, I know there are probably a number of people that are scared off by the low volumes, but we're looking for opportunity here - companies that could be bought, those that are under the radar, and so on.
Once the stock selections are made, the second step is to build a portfolio that will reduce overall risk. I like using a mean-variance model set up on 52 weeks of data to determine the highest return on the least incremental risk. I know all the criticisms against Modern Portfolio Theory, but until there's a widely held conclusion denoting a better method of risk reduction, this is the one I'm sticking with.
With that said - below are the stock selections and distribution:
- Palomar Technologies (PMTI) - A 29% increase in insider ownership over the past 6 months, and a strong balance sheet has me believing that this stock has the potential to break out.
- Omeros International (OMER) - A 27% increase in insider ownership and a large pipeline make this a very attractive stock to own. Additionally, this stock has been beaten down over the month of July due to profit taking and a stock offering, so it currently presents a very viable buying opportunity.
- Carriage Services (CSV) - Our lone venture into the services sector naturally would need to be a funeral services provider. Let's face it, we're all going to die. But since May the directors in on the board have been snapping this stock up, resulting in a 10% increase in insider ownership. Other reasons to like the stock are a strong upward trend, a healthy balance sheet, and quite a few buy recommendations.
- Fuel Tech (FTEK) - This stock is only a small piece of our portfolio, but I think there's some viable upside with this stock. It seems to have been beaten down a bit, but there has been some strong buying behavior both in terms of a buy-back as well as quite a lot of insider buying - insider transactions are up 62%.
- Numerex (NMRX) - Continuous upward movement coupled with a recent streak of insider buying makes me believe there is some more room for this stock to grow before it reaches its ceiling.
- Healthcare Select SPDR (XLV) - Since this portfolio is so heavily weighted into the healthcare sector, we need some way to reduce our sector wide exposure. Accordingly, we can use a short position to reduce over-all risk.
In the end, I'm recommending using this particular portfolio for only 3 months. That puts an expiration date right about Halloween (10/31/2012). According to the portfolio theory, we can expect a return averaging 6% over that time frame with some substantial volatility. Additionally, I will post updates over time to track performance.