In the following article, I present three companies that are experiencing a divergence in fundamentals and market value. I believe that each of these three companies represents an excellent buying opportunity in the near future.
Prior to reading the article, there are three things that the reader should be familiar with: return on assets, return on equity and market cap. Return on assets is the net income of the firm divided by total assets and it shows the efficiency of the firm in utilizing its assets to generate revenue. Return on equity is the net income of the firm divided by directly invested shareholder equity and it shows the effectiveness of management to utilize investments to generate a return for the firm. Market capitalization is the shares outstanding times the stock price and it represents the dollar value of the firm.
Infosys Limited (INFY)
The first organization we will examine is Infosys Limited. Infosys has decreased in share price nearly 14% this year, shedding over $5 billion in market cap. This decrease has been in direct contrast to the fundamental performance of the firm as seen in the chart below.
The chart shows the return on assets, return equity, and market cap for Infosys during the past 5 years. The first thing to examine is that return on assets and return on equity declined from 2008 until 2011. This essentially means that the firm began utilizing assets less efficiently and managing shareholder investment less effectively during this time period. As the firm decreased its performance in these key metrics, the market initially responded by decreasing the value of the firm between 2008 and early 2009. It is very interesting to note that the market has not consistently valued Infosys according to its returns. Between 2009 and 2011, the stock rallied and over $25 billion in value was added to the firm. I believe that this rally was based on the market-wide rally in which nearly every stock rose. In 2011, the market once again "remembered" that Infosys was declining in its management of assets and shareholder equity and stock price declined nearly 40%. Beginning in mid-2011 however, Infosys made a clear turnaround in which the firm began once again to use its assets and shareholder equity to bring revenue into the firm.
The fact that Infosys is increasing its returns on assets and equity yet the market value is declining denotes a clear investment opportunity. Since Infosys is steadily becoming better at generating revenue for the firm, I believe that the market will "wake up" and begin pricing the stock accordingly. For the most part, changes in return on assets and return on equity have driven the market value for Infosys for the past 5 years. I believe that the current divergence in firm performance and market performance represents an investment opportunity.
Technically speaking, a clear market-bottoming pattern is potentially forming in Infosys. Price has been in a downtrend for 18 months, but gave a telling signal in July when it was unable to fall below $38 per share and continue the downtrend. I do not believe that investors should blindly purchase shares, however. I feel that the best time to purchase shares is when the market has violated the definition of a downtrend and that is when prices have risen above $47 per share - or the highs of the current period of consolidation.
C.H. Robinson Worldwide (CHRW)
Shareholders of C.H. Robinson Worldwide have had a fairly arduous year in which prices have declined 18%. This decline represents a decrease of $2 billion in market cap as well as a great buying opportunity. The chart below shows the return on assets, return on equity and market cap of CHRW during the past 5 years.
The chart clearly shows that return on assets and return on equity have been steadily increasing for the past 5 years. This means that the firm has progressively been better able to utilize assets and direct shareholder investment to bring in profit to the firm. The alert investor will quickly note the divergence in firm performance and market performance. Since 2011, the market has shed over $3 billion in value from CHRW, yet returns have increased. This represents an ideal investment opportunity - the market is paying discounted prices for a company that is delivering exceptional performance.
Technically speaking, CHRW is clearly in a downtrend. I believe that the best moment to participate in this type of situation is to wait for the downtrend to end rather than attempting to pick the bottom of prices. That said, I believe a buy stop at $60 per share will protect the investor from rushing into a declining stock and allow the opportunity to participate once the price truly has bottomed out.
This year, shareholders of Herbalife have been devastated with a decline of 30% in share value. With over $2 billion of wealth erased, many investors are still in shock from the large drop, which primarily occurred in May of this year. I believe that this drop in share price was a temporary price shock due to a brief period of underperformance. In the following chart, the return on assets, return on equity, and market cap of Herbalife can be seen.
Since the middle of 2009, Herbalife has become progressively better at generating a return on its assets and directly invested shareholder equity. This means that the firm is essentially performing better both from an organizational and management standpoint. Traditionally, the market responds by rewarding firms in the process of bettering themselves by increasing the value of the firm. This relationship of performance and market value can clearly be seen between mid-2009 and early-2012. During these years, performance increased and the market responding by doubling the value of Herbalife. In May of this year however, performance continued to increase but market value dramatically decreased. I believe that this decrease was caused by short-sighted speculators and the fundamental picture of the firm is still one of performance. That said, I believe that any prudent investor who purchases Herbalife purchases a pullback in a great company.
Technically speaking, Herbalife is currently in a breakdown of the primary trend. The current pause in trend direction warrants caution among potential investors. Since prices have broken the ascending trend line, the stock is technically neither in an uptrend or a downtrend. If prices fall below $42 per share, then a new downtrend has begun and investors should exit long positions in the stock. If however, prices increase above $55, then the uptrend will have once again resumed and new investment is warranted. That said, I believe a buy stop order placed at $55 will trigger a prudent investment into Herbalife.