In late July, I had suggested that there were some stocks that had not fully participated in the market rally since June 2012. I argued that part of the reason these stocks underperformed compared to the market was that the euro had not stabilized. I predicted that as the market resiliency lasted for a while longer, these stocks would catch up to the market and wildly over perform. The 5 stocks that I suggested taking a long position in were Morgan Stanley (MS), Green Mountain Coffee Roasters (GMCR), iShares Silver ETF (SLV), NetApp (NTAP) and Cree (CREE). The initial article is here: Trades For The Approaching Euro Strength
An equal weighted portfolio of those 5 stocks has increased by 21.79% in a little more than a month versus approximately 4.5% for the market.
In this article, I would like to go over the main reasons that I suggested these stocks in my original article and analyze how to adjust that portfolio and realize some profits based on the recent developments and price action.
Morgan Stanley (Up 18.8%): The main reason holding back the Morgan Stanley stock before July 2012 was persistent euro (the currency) weakness. Morgan Stanley is not a juggernaut compared to its peers, so it is perceived as the most vulnerable to Eurozone problems. As the euro stabilized, Morgan Stanley caught up to the market and hence the outperformance.
However, Morgan Stanley remains an extremely high-beta investment. Given the amount of uncertainty that will undeniably be associated with the ECB news flow in September 2012, it is a good idea to realize the profits from MS on this trade. Medium-term, Morgan Stanley remains undervalued in my opinion, but there will be better buying opportunities as more clarity develops on the ECB actions.
iShares Silver Trust (Up 17.4%): This was another trade that was purely dependent on an expected stabilization in the euro. Silver had been range bound for almost two months before it finally rallied as the positive market sentiment proved persistent. Although the fundamental reasons underlying this trade is quite similar to Morgan Stanley, trading silver is a lot trickier. SLV is not yet overbought, so if the euro resiliency persists, it is bound to rally by at least another 10%. On the other hand, this is a very volatile asset and not realizing a 18% profit in a month is a little greedy.
The decision on this trade is dependent on an investor's risk profile. I do not expect a straightforward bond buying program from the ECB yet, so I would suggest taking profits on this trade also.
Green Mountain Coffee Roasters (Up 38.4%): This was a trading suggestion based on valuation. It has also proved to be the best performing stock in the 5 stock portfolio I suggested. Since the brutal selloff in early May of 2012, Green Mountain Coffee Roasters has moved into value category. I am bearish on the stock medium-term because it is a blown out momentum stock. However, before the stock resumes its bearish trend, I expect it to retrace some of its losses from the $65 level as value investors step in. My short-term price target for Green Mountain Coffee Roasters is $35, after which I expect it to resume its downward trend. This is a stock that is worth analyzing in detail, and there are tremendous opportunities for taking advantage of the short-term swings in the stock. To get more details on my investment analysis on Green Mountain Roaster, you can check out my previous articles below:
NetApp (Up 10.5%): This is one of the most undervalued companies in the popular cloud tech arena in my opinion. NetApp trades at roughly 9X earnings and 1.3X sales after adjusting for cash on the balance sheet. Although it has outperformed the market, it still trades at very reasonable multiples compared to some other popular cloud stocks such as Salesforce.com (CRM), which trades at 7.5X sales. The one thing that is a detriment to huge upside on this stock is the fact that it does not seem to be a takeover target. Cloud arena acquisitions have largely been for unprofitable but very high growth and high multiple firms. NetApp is not that kind of a firm and hence lacks the premium associated with such an M&A opportunity.
In my opinion, this stock will be much more stable compared to the other stocks in the portfolio. Therefore, it can be kept a little longer until it reaches more aggressive valuation multiples.
Cree (Up 24.4%): This has been another stock that I suggested going long based on valuation. The stock is not necessarily very cheap at 30X P/E and 2.2X Sales. However, this is a company that has a dominant position in its sector and the sector itself has huge growth potential. Such companies usually are valued much more aggressively. Another issue at consideration is that the high valuation multiples are a result of the recent weak financial performance of the company. Even a modest improvement in the company's profitability will quickly bring down the valuation multiples and put the company in value category. I remain very bullish on Cree medium-term. I also find it to be a rather stable stock compared to the amount of possible upside.
About the Portfolio As A Whole
In my opinion, a 21.8% profit in a month is extremely good and it would not be wise to hold on to these positions, given all the uncertainty that awaits investors in September 2012. I remain bullish on all of the 5 stocks above. However, in all of the volatility that will ensue, there will probably be better entry levels to initiate these positions. Therefore, my suggestion would be to liquidate the portfolio above, realize all of the 20%+ profit and then wait for those better entry levels based on how the ECB action develops.
For investors who want to remain fully invested, my suggestion would be to remain long the positions based on valuation, which are GMCR, NTAP and CREE. Then the investor should hedge that with going short MS and SLV. The value of the long position and the hedge should be approximately the same. Such a trade should be safe from any shocks that might arise from an ECB surprise, but still enjoy some upside if the market stays resilient. I will also try to post a follow-up article to this last hedged trade suggestion. Investors who find my trading suggestions and analysis of good quality can use the "Follow" feature of SA to get that article.
Disclosure: I am long GMCR.