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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:

STDEV PB vs. Avg PB
(Click to enlarge)

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:

STDEV PB vs. Avg. PB
(Click to enlarge)

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:

ROE vs. Avg. PB
(Click to enlarge)

ROE vs. Avg. PB Zoom
(Click to enlarge)

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:

Lodging ROW vs. PB Ratio
(Click to enlarge)

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

OEH

Orient-Express Hotels

Bermuda

1.66

1.01

-6.76%

H

Hyatt Hotels

USA

55

1.63

1.29

2.37%

GET

Gaylord Entertainment

USA

111.53

1.8

1.85

1.73%

HMIN

Home Inns & Hotels Management

China

1.5

1.87

6.76%

SVN

7 Days Group Holdings

China

19.58

1.32

1.87

10.15%

CTRP

Ctrip.com International

China

15.81

3.44

1.89

12.81%

HTHT

China Lodging Group

China

45.27

2.13

2.34

5.49%

EXPE

Expedia

USA

20.4

1.91

3.14

13.95%

HOT

Starwood Hotels & Resorts Worldwide

USA

18.58

1.73

3.36

19.26%

WYN

Wyndham Worldwide

USA

20.76

1.7

3.74

16.96%

IHG

Intercontinental Hotels Group

UK

13.28

4.23

10.37

110.18%

CHH

Choice Hotels International

USA

21.77

3.86

MAR

Marriott International

USA

62.38

1.03

3483.33%

MHGC

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.

Source: Top Down Search For Alpha: Lodging Industry At Top