Financial analysts have to pick their battles because investment analysis is a very labor intensive process. Even if you enjoy it, there is just too much information and too many companies and industries to cover. Worse yet, spending time towards this end can be brutal since applied calculations and reading SEC filings are a form of torture for most people.
In order to focus precious research efforts on the most fruitful areas, different industries were compared to determine which were the most promising candidates for stock picking. This top-down approach identified lodging as a promising candidate for creating a long-biased position.
Stocks and industries were considered based on the following criteria:
Stocks were required to be optionable and shortable. To reap alpha from an industry long and short positions must be taken. This screen restricts consideration to industries where short positions are available. It also serves to screen out tiny market cap and illiquid companies.
Industries were required to have more than 10 optionable and shortable stocks. As investors, we should be selective when we take positions. A greater number of stocks will usually contain bigger opportunities for generating alpha.
A plot of price-to-book ratio standard deviations against price-to-book industry averages provides very little insight:
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Oil and gas refining and marketing stocks include members with very high valuations. This is not uniform across all industry stocks, resulting in a high standard deviation. A closer look at the remaining valuations is very similar:
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The independent oil and gas industry has high valuations and a high standard deviation of valuations, too.
A plot of average industry return on equity and price-to-book ratios also visualizes opportunities:
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There isn't much of a straight line relationship, which indicates that some industry averages dominate others. A linear regression was used to calculate excess ROE by calculating trend-based ROE based on price-to-book ratios and was subtracting it from actual ROE. The results follow:
Industry | # of Stocks | Average P/B | Average ROE | Projected ROE | Excess ROE |
Lodging | 11 | 2.98 | 3.06 | 0.32 | 2.74 |
CATV Systems | 11 | 13.67 | 2.89 | 1.49 | 1.40 |
Oil & Gas Pipelines | 32 | 3.53 | 1.73 | 0.38 | 1.35 |
Oil & Gas Refining & Marketing | 23 | 176.66 | 19.70 | 19.28 | 0.42 |
Agricultural Chemicals | 13 | 3.23 | 0.47 | 0.35 | 0.12 |
Education & Training Services | 20 | 2.60 | 0.29 | 0.28 | 0.01 |
Major Integrated Oil & Gas | 18 | 1.62 | 0.16 | 0.18 | -0.02 |
Savings & Loans | 20 | 1.02 | 0.08 | 0.11 | -0.04 |
Property & Casualty Insurance | 55 | 0.92 | 0.06 | 0.10 | -0.04 |
Credit Services | 19 | 1.78 | 0.15 | 0.19 | -0.04 |
Regional - Southeast Banks | 11 | 1.17 | 0.08 | 0.13 | -0.04 |
Regional - Midwest Banks | 19 | 1.06 | 0.07 | 0.12 | -0.05 |
Foreign Regional Banks | 12 | 1.31 | 0.09 | 0.14 | -0.05 |
Regional - Northeast Banks | 17 | 1.18 | 0.07 | 0.13 | -0.06 |
Health Care Plans | 15 | 1.70 | 0.13 | 0.19 | -0.06 |
Life Insurance | 20 | 1.06 | 0.06 | 0.12 | -0.06 |
Diversified Utilities | 15 | 1.42 | 0.09 | 0.15 | -0.07 |
Paper & Paper Products | 16 | 1.43 | 0.09 | 0.16 | -0.07 |
Data Storage Devices | 11 | 1.65 | 0.11 | 0.18 | -0.07 |
Regional - Pacific Banks | 18 | 1.67 | 0.10 | 0.18 | -0.09 |
Oil & Gas Drilling & Exploration | 58 | 3.82 | 0.33 | 0.42 | -0.09 |
Technical Services | 12 | 1.38 | 0.06 | 0.15 | -0.09 |
Electric Utilities | 45 | 1.53 | 0.07 | 0.17 | -0.10 |
Railroads | 15 | 2.21 | 0.14 | 0.24 | -0.10 |
Metal Fabrication | 13 | 1.94 | 0.11 | 0.21 | -0.10 |
REIT - Diversified | 28 | 1.37 | 0.04 | 0.15 | -0.11 |
Industrial Equipment Wholesale | 11 | 2.72 | 0.17 | 0.30 | -0.13 |
Specialty Chemicals | 41 | 2.70 | 0.16 | 0.29 | -0.13 |
Semiconductor Equipment & Materials | 33 | 1.84 | 0.07 | 0.20 | -0.14 |
Specialized Health Services | 12 | 2.43 | 0.13 | 0.27 | -0.14 |
Industrial Equipment & Components | 14 | 2.30 | 0.11 | 0.25 | -0.14 |
Diversified Machinery | 48 | 2.61 | 0.14 | 0.28 | -0.14 |
Aerospace/Defense Products & Services | 28 | 3.16 | 0.20 | 0.34 | -0.15 |
Regional Airlines | 11 | 1.85 | 0.05 | 0.20 | -0.15 |
Heavy Construction | 15 | 1.64 | 0.03 | 0.18 | -0.15 |
Trucking | 14 | 3.41 | 0.22 | 0.37 | -0.15 |
Management Services | 13 | 2.90 | 0.16 | 0.32 | -0.16 |
REIT - Office | 20 | 1.67 | 0.02 | 0.18 | -0.16 |
Staffing & Outsourcing Services | 17 | 4.01 | 0.27 | 0.44 | -0.16 |
Rental & Leasing Services | 19 | 2.64 | 0.12 | 0.29 | -0.16 |
Property Management | 13 | 1.76 | 0.03 | 0.19 | -0.17 |
Processed & Packaged Goods | 24 | 2.99 | 0.16 | 0.33 | -0.17 |
Silver | 11 | 2.55 | 0.10 | 0.28 | -0.18 |
Asset Management | 43 | 1.97 | 0.04 | 0.22 | -0.18 |
Packaging & Containers | 13 | 2.68 | 0.11 | 0.29 | -0.18 |
Investment Brokerage - National | 16 | 1.25 | -0.05 | 0.14 | -0.19 |
Wireless Communications | 30 | 2.51 | 0.08 | 0.27 | -0.19 |
Networking & Communication Devices | 11 | 1.97 | 0.02 | 0.21 | -0.19 |
Apparel Stores | 41 | 3.19 | 0.16 | 0.35 | -0.19 |
Scientific & Technical Instruments | 32 | 2.62 | 0.09 | 0.29 | -0.20 |
Gas Utilities | 24 | 2.61 | 0.09 | 0.28 | -0.20 |
Oil & Gas Equipment & Services | 39 | 2.49 | 0.07 | 0.27 | -0.20 |
Beverages - Soft Drinks | 11 | 3.62 | 0.19 | 0.40 | -0.21 |
Semiconductor - Specialized | 28 | 2.51 | 0.05 | 0.27 | -0.22 |
Industrial Metals & Minerals | 52 | 2.00 | -0.01 | 0.22 | -0.23 |
REIT - Retail | 27 | 2.20 | 0.01 | 0.24 | -0.23 |
Auto Parts | 29 | 2.59 | 0.04 | 0.28 | -0.24 |
Diversified Investments | 15 | 8.81 | 0.71 | 0.96 | -0.25 |
Money Center Banks | 20 | 1.38 | -0.10 | 0.15 | -0.25 |
Residential Construction | 14 | 1.73 | -0.07 | 0.19 | -0.25 |
Textile - Apparel Clothing | 18 | 3.47 | 0.11 | 0.38 | -0.27 |
Computer Peripherals | 12 | 2.10 | -0.04 | 0.23 | -0.27 |
REIT - Industrial | 13 | 2.94 | 0.04 | 0.32 | -0.28 |
Diversified Communication Services | 20 | 2.44 | -0.01 | 0.27 | -0.28 |
Shipping | 37 | 2.11 | -0.05 | 0.23 | -0.28 |
Semiconductor - Broad Line | 24 | 2.69 | 0.00 | 0.29 | -0.29 |
Steel & Iron | 25 | 1.49 | -0.17 | 0.16 | -0.33 |
REIT - Hotel/Motel | 11 | 1.27 | -0.20 | 0.14 | -0.34 |
Technical & System Software | 14 | 4.37 | 0.13 | 0.48 | -0.34 |
Chemicals - Major Diversified | 17 | 3.32 | 0.01 | 0.36 | -0.35 |
Internet Information Providers | 32 | 3.93 | 0.07 | 0.43 | -0.36 |
Waste Management | 13 | 2.70 | -0.07 | 0.30 | -0.37 |
Specialty Retail, Other | 24 | 4.41 | 0.11 | 0.48 | -0.38 |
Diversified Electronics | 31 | 1.88 | -0.20 | 0.20 | -0.41 |
Catalog & Mail Order Houses | 12 | 3.94 | 0.00 | 0.43 | -0.43 |
Business Services | 75 | 7.57 | 0.39 | 0.83 | -0.44 |
Internet Software & Services | 19 | 4.58 | 0.05 | 0.50 | -0.45 |
Grocery Stores | 11 | 4.59 | 0.01 | 0.50 | -0.49 |
Semiconductor - Integrated Circuits | 42 | 1.91 | -0.31 | 0.21 | -0.52 |
Telecom Services - Domestic | 13 | 3.71 | -0.14 | 0.41 | -0.55 |
Multimedia & Graphics Software | 16 | 3.17 | -0.21 | 0.35 | -0.55 |
Resorts & Casinos | 17 | 4.49 | -0.07 | 0.49 | -0.56 |
Application Software | 61 | 4.72 | -0.06 | 0.51 | -0.58 |
Business Software & Services | 38 | 5.72 | 0.03 | 0.62 | -0.59 |
Drug Manufacturers - Major | 22 | 3.77 | -0.21 | 0.41 | -0.62 |
Textile - Apparel Footwear & Accessories | 14 | 6.68 | 0.10 | 0.73 | -0.63 |
Medical Appliances & Equipment | 54 | 3.99 | -0.30 | 0.44 | -0.73 |
Industrial Electrical Equipment | 34 | 6.47 | -0.03 | 0.71 | -0.73 |
Restaurants | 31 | 10.57 | 0.29 | 1.15 | -0.87 |
Drug Manufacturers - Other | 30 | 5.84 | -0.29 | 0.64 | -0.93 |
Medical Instruments & Supplies | 42 | 6.60 | -0.22 | 0.72 | -0.94 |
Medical Laboratories & Research | 13 | 5.61 | -0.35 | 0.61 | -0.97 |
Communication Equipment | 41 | 1.75 | -0.80 | 0.19 | -0.99 |
Gold | 35 | 9.51 | 0.00 | 1.04 | -1.04 |
REIT - Residential | 26 | 10.52 | 0.04 | 1.15 | -1.11 |
Diagnostic Substances | 12 | 5.41 | -0.80 | 0.59 | -1.40 |
Information Technology Services | 22 | 13.50 | 0.07 | 1.47 | -1.41 |
Biotechnology | 108 | 13.69 | -0.75 | 1.19 | -1.95 |
Independent Oil & Gas | 92 | 23.39 | 0.96 | 3.47 | -2.50 |
General Building Materials | 18 | 23.70 | -0.03 | 2.59 | -2.62 |
Alpha hunters might consider net long positions in industries with positive excess ROE, market neutral positions for industries with slightly negative excess ROE, and net short positions in industries with substantially negative excess ROE.
For example, exceptional excess ROE in the lodging industry is worth further attention. A plot of companies within the lodging industry reveals that there are some stocks which are more attractively priced than others:
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Four above-trend lodging stocks above the line are presented in bold and three below trend socks are presented in red:
Ticker | Company | Country | P/E | P/S | P/B | ROE |
Orient-Express Hotels | Bermuda | 1.66 | 1.01 | -6.76% | ||
Hyatt Hotels | USA | 55 | 1.63 | 1.29 | 2.37% | |
GET | Gaylord Entertainment | USA | 111.53 | 1.8 | 1.85 | 1.73% |
Home Inns & Hotels Management | China | 1.5 | 1.87 | 6.76% | ||
7 Days Group Holdings | China | 19.58 | 1.32 | 1.87 | 10.15% | |
Ctrip.com International | China | 15.81 | 3.44 | 1.89 | 12.81% | |
China Lodging Group | China | 45.27 | 2.13 | 2.34 | 5.49% | |
Expedia | USA | 20.4 | 1.91 | 3.14 | 13.95% | |
Starwood Hotels & Resorts Worldwide | USA | 18.58 | 1.73 | 3.36 | 19.26% | |
Wyndham Worldwide | USA | 20.76 | 1.7 | 3.74 | 16.96% | |
Intercontinental Hotels Group | UK | 13.28 | 4.23 | 10.37 | 110.18% | |
Choice Hotels International | USA | 21.77 | 3.86 | |||
Marriott International | USA | 62.38 | 1.03 | 3483.33% | ||
Morgans Hotel Group | USA | 0.82 |
I should caution that of the bolded long candidates, HMIN, SVN, and CTRP are based in China and require more balance sheet scrutiny. Hyatt, however, is a solid long candidate and is based in the United States. Of the short candidates, HTHT is particularly attractive since its valuation multiples are uniformly high. On the other hand, EXPE and WYN require more research since their valuations are not as extreme.
Based on this work, a net long position with a Hyatt long partially hedged by a China Lodging Group short would be promising.
Please read the article disclaimer.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
