Almost Family: Finding Stocks That Work

I just finished reading Trader Mark's article “The Last Days of the Long Investor?” on Seeking Alpha, and while generally I've enjoyed his stuff and don't find too much to disagree with, in this case I have to disagree with a good portion of it.

One point I do agree with is that managed money is good work if you can get it. Even though sites like turnkeyhedgefund and others will let you start your very own fund from your mother's basement for $5000, it's doubtful that you will get many investors, so it's not the easy gig that some think it is. In the past, raising money was about who you know; now its becoming more and more about who knows you.

The main point though, is that the market has no logic, is dominated by quants from MIT (the same type of guys who can't come up with anything more creative to do in a job hunt than hang a "feed me" sign around the neck like a bum and hope someone has pity on them and that maybe the entire world is going to hell in a hand basket). In stating that this has been a lost decade for buy and holders, he acts as though it's the only time that this may have happened in history, when in fact it's happened a few times before and its likely it will happen again in 50 or so years.

In consistent dollar terms, the DOW peaked at around 3100 in the mid 1960s and declined to 850 by 1981, a 72% decline during a 15 year period. If you think that the last 10 years have stunk, just imagine how people felt during that 15 year period. Not only did investors lose a bunch of money buying and holding during the entire period from the mid 60s to the early 80s, the DOW did not recover its old highs until 1995, a 30 year period before breaking even after inflation. The idea that buying and holding stocks gives you some sort of constitutional right to make money is a silly one, bought and paid for by the mutual fund and brokerage industry, but untrue nevertheless.

I have no intention of giving away a cow here since I still sell milk, but there is still plenty of money to be made in the market. You have to be creative, you have to have your own plan and follow it, and you cannot spend your time screaming that the market is being stupid while you are the last remaining vestige of sanity, but I expect that has always been the case. Obviously one trade does not prove anything, but I'd like to use one as an example of something that still does work.

(As an aside, I started out as a technician, actually as a day trader at age 19 in 1996. This was a great time in the market and I thankfully made a lot of money, enough to learn how lucky, reckless and stupid I had been in making most of it and figure out how to really do things. I still start out with the technicals though, I think that relative strength is one of the best ways to look at stocks and groups of stocks. So with this in mind, each weekend Anthony Tsung and I will look for stocks that have been outperforming the market or underperforming it. What I mean is that if the market is down, I look for stocks that went sideways or up, if the market is up, I'm building a list of stocks that went up more than the market did, and also a list of stocks that couldn't do anything. From this I have my research list. Now we have to work the list down, because simply buying a stock because it's “strong” is sort of like taking morphine simply because it makes you feel good; in the short term you might get something out of it, but in the long term it just makes you sick.) 

Almost Family Inc (NASDAQ:AFAM) is a stock that had shown excellent relative strength while the market tanked. If you look at a Point and Figure chart or a bar chart, you see a very nice long base, with $25 as a breakout point. This was the first thing that attracted me to AFAM. I next used my ThomsonOneAnalystic (anything is possible in America - if I can make enough to afford Thomson, there is hope for the rest of humanity, trust me on that) and discovered that only three analysts covered the stock, and barely so at that. It also had less than 10% of its shares outstanding owned by banks and funds. This for a company with an EPS growth rate of nearly 50%, a return on equity of 25% and high insider ownership in a sector that stands to benefit from demographic trends.

So, you have to ask yourself, “Why would this be?" Normally the reason is that for some hidden reason the stock is really a piece of crap and you should stay miles away from it just like everyone else, but on occasion you find a gem, and AFAM was, but a couple of things kept the analysts and funds away; some of them could easily be changed, some of them could not.

One of the first books I read on investing was Peter Lynch's “One up on Wall Street”; one of the things that stuck out and was interesting to me was all the reasons a fund might not be able to buy a perfectly good stock in a perfectly good company. When I decided to leave my technical-only methods and explore the fundamentals, this was a key thing in my mind - finding stocks that for some reason, RIGHT NOW, Wall Street CANNOT LOVE IT. They might be watching it and wanting like crazy to love it, but for some reason they CAN'T. In the case of AFAM,  you have a small flat (5.5million shares), and there is not much you can do about that. You also had a company that at $25 per share had a market value of $203 million. In my experience talking to analysts (my business partner Anthony used to be one at Merrill), they typically don't like stocks under around $250 million to $500 million market cap unless they have an I-banking relationship with them. For this reason alone, many on the Street would be unable to buy AFAM because of their own rules, however once it went above those levels they would be free to do so.

The stock price being under $25 is also something that some people find unattractive, but that's fixed the instant the stock breaks out, so you don't even have to worry about that one. Last year's sales total was around $133 million, under the $150 to $250 million minimum a lot of people are comfortable with, but since AFAM continues to grow revenue pretty sharply on a quarter over quarter basis, you can assume that won't be a problem for too long, either.

I could go on and on with the six or seven (to add some confusion to the issue I'll say "or ten", too) other things we look at, but again I have milk to sell, and giving away cows does nothing to help me in that department. In any case, all is not lost. Hard work, rigid analytic work, getting your hands dirty and digging is still a method that works very well, thank you very much.

Disclosure: none

Comments

[leh:]

Nice piece BF! Some very helpful info here as far as what the big boys avoid and why. AFAM looks like a great find. Thanks for the info.

LEH

2008 Aug 17 11:15 AM

[Brandon-Fre...:]

I'm glad it helped you.

2008 Aug 18 01:48 PM