In this report, we highlight stocks that demonstrate solid growth prospects at a reasonable price (GARP) and provide an update of last month's report and our October 5 rebalancing note. For older reports, you can visit this link.
Our criteria for selecting stocks in these model portfolio strategies, which heavily weight proxies for cash flow growth and ROIC, include the following:
- Relative Value
- Operating Momentum
- Consensus Estimate Revision Momentum
- Fundamental Quality
Long Rebalancing Actions
As we noted just prior to the close on October 31, 2017, we assumed 18 stocks left the long-only model, 19 were added, and 17 were rebalanced. This 36-stock theoretical long model assumes a 2.78% weight for each stock. The long model portfolios are composed of high-quality stocks.
Close Long Positions
Burlington Stores, Inc. (BURL)
Compañía Cervecerías Unidas S.A. (CCU)
TC PipeLines, LP (TCP)
SVB Financial Group (SIVB)
Exelixis, Inc. (EXEL)
Agilent Technologies, Inc. (A)
Masimo Corporation (MASI)
ManpowerGroup Inc. (MAN)
Graco Inc. (GGG)
EMCOR Group, Inc. (EME)
Donaldson Company, Inc. (DCI)
Valmont Industries, Inc. (VMI)
Applied Industrial Technologies, Inc. (AIT)
InterDigital, Inc. (IDCC)
Advanced Energy Industries, Inc. (AEIS)
Intuit Inc. (INTU)
Teck Resources Limited (TECK)
United States Steel Corporation (X)
Hold/Rebalance Long Positions
Thor Industries, Inc. (THO)
Kohl's Corporation (KSS)
Evercore Inc. (EVR)
East West Bancorp, Inc. (EWBC)
American Equity Investment Life Holding Company (AEL)
Raymond James Financial Inc. (RJF)
MasTec, Inc. (MTZ)
Trex Company, Inc. (TREX)
Allison Transmission Holdings, Inc. (ALSN)
Micron Technology, Inc. (MU)
Vishay Intertechnology, Inc. (VSH)
YY Inc. (YY)
Facebook, Inc. (FB)
Arista Networks, Inc. (ANET)
Norbord Inc. (OTC:OSB)
Kronos Worldwide, Inc. (KRO)
Trinseo S.A. (TSE)
Open Long Positions
TEGNA Inc. (TGNA)
Yum! Brands, Inc. (YUM)
Peabody Energy Corporation (BTU)
Ameriprise Financial, Inc. (AMP)
Federated Investors, Inc. (FII)
Synovus Financial Corp. (SNV)
JPMorgan Chase & Co. (JPM)
Western Alliance Bancorporation (WAL)
Cullen/Frost Bankers, Inc. (CFR)
Cathay General Bancorp (CATY)
Armstrong World Industries, Inc. (AWI)
Illinois Tool Works Inc. (ITW)
Norfolk Southern Corporation (NSC)
Cirrus Logic, Inc. (CRUS)
MKS Instruments, Inc. (MKSI)
Teradyne, Inc. (TER)
Cabot Corporation (CBT)
Huntsman Corporation (HUN)
Methanex Corporation (MEOH)
Short Sale Rebalancing Actions
Just prior to the October 31, 2017, close, we assumed that 11 stocks left the short sale model portfolio, 7 were added, and 14 were rebalanced. This 21-stock theoretical model portfolio assumes a 4.76% weight for each stock.
This short sale model is composed of low-quality stocks, and only tends to work well during periods of high uncertainty or volatility in the market. Low-quality stocks do tend to outperform high-quality stocks during market rallies as the market prices in expectations for a sharp recovery in fundamentals.
Close Short Sale Positions
Penske Automotive Group, Inc. (PAG)
Adient plc (ADNT)
National Oilwell Varco, Inc. (NOV)
Voya Financial, Inc. (VOYA)
Alnylam Pharmaceuticals, Inc. (ALNY)
Jacobs Engineering Group Inc. (JEC)
Textron Inc. (TXT)
KBR, Inc. (KBR)
Integrated Device Technology, Inc. (IDTI)
PTC Inc. (PTC)
The Sherwin-Williams Company (SHW)
Hold/Rebalance Short Sale Positions
Under Armour, Inc. (UAA)
MetLife, Inc. (MET)
Puma Biotechnology, Inc. (PBYI)
Agios Pharmaceuticals, Inc. (AGIO)
Penumbra, Inc. (PEN)
ZTO Express (Cayman) Inc. (ZTO)
Colfax Corporation (CFX)
Univar Inc. (UNVR)
Fluor Corporation (FLR)
Flowserve Corporation (FLS)
MACOM Technology Solutions Holdings, Inc. (MTSI)
ViaSat, Inc. (VSAT)
Cree, Inc. (CREE)
The Mosaic Company (MOS)
Open Short Sale Positions
Mattel, Inc. (MAT)
Spark Therapeutics, Inc. (ONCE)
Portola Pharmaceuticals, Inc. (PTLA)
UniFirst Corporation (UNF)
Symantec Corporation (SYMC)
Summit Materials, Inc. (SUM)
Axalta Coating Systems Ltd. (AXTA)
Favorite ideas for November 2017
Our favorite long idea this month is Illinois Tool Works Inc. (ITW). This stock stands out because it shares a ranking profile of previously very successful names, and Industrials in general seem to be looking more attractive. In addition, it appears the sell-side consensus estimates may be too conservative for 2018. If ROIC continues to improve through 2018 instead of flattening out as currently implied by consensus, the stock may experience another leg higher.
In our opinion, Micron Technology (MU) remains one of the strongest long ideas in the industry, and Cree, Inc. (CREE) remains one of the weakest - despite the optimism expressed by its CEO during its October 17 financial report. Therefore, we are once again suggesting a long MU/short CREE pair trade.
October 2017 Returns
High-quality stocks consistently outperformed low-quality stocks in October.
The theoretical Core Long Model portfolio finished October 2017 up +4.22% on a simple cumulative return basis, versus the S&P 500 Index up +2.34% and the S&P Composite 1500 Index up +2.16%.
Stocks in the theoretical Core Short Model portfolio finished up +1.78% for the assumed inverse short sale loss of -1.78%.
The theoretical Core Long/Short Model portfolio finished up +2.39% (4.16% -1.78% = +2.39%).
For the 10 months through October 31, the Core Long Model is up +18.99% on a simple cumulative return basis and up +20.13% on a compound return basis. In contrast, the S&P 500 Index is up +14.20% and +15.03%, respectively, over the same period.
For the 10 months through October 31, the Core Long/Short Model is up +18.43%, ahead of the Barclay Long/Short Index of +7.04% (compound returns).
For October 2017, on a simple cumulative return basis, the Opportunistic Long Model portfolio was up +3.83%, and the Opportunist Long/Short Model portfolio was up +2.05% (up +3.87% and +2.05% on a compound return basis, respectively).
The theoretical Opportunistic Long Model portfolio assumed a 30% base cash position from the first trading day of the month through just prior to the October 12 close, when it then assumed a 0% base cash position.
This theoretical model uses the same basket of stocks and stock price targets of the Core model, but assumes a 30% base cash position or 100% base cash position during extreme market volatility, or when certain portfolio target returns or losses are achieved.
Theoretical long stock returns October 5-31, 2017
We had 2 favorite long ideas last month, Micron Technology and Agilent Technologies (A), which appreciated +12.55% and +3.55% since the October 5 model portfolio rebalancing date, respectively.
The best performing stock in the long model since was Trex Company Inc. (NYSE:TREX), up +25.80% for the October 5-31 period. The worst performing stock was Teck Resources Limited (TECK), down -11.17%. We provided a brief summary of TREX's impressive 3Q17 quarterly results earlier.
Theoretical short sale stock returns for October 5-31, 2017
The best short sale idea for October was Under Armour Inc. (UAA), which was down -24.26% for an assumed short sale gain of +24.26%. The worst idea was Cree Inc. (CREE), which appreciated 15.59% through its stop-loss date of October 19 for the assumed short sale loss of -15.59%.
Long MU/Short CREE underperformed in October 2017
Also on October 5, we suggested a long/short pair trade of MU/CREE, which performed poorly. Optimism expressed by CREE's new CEO, who has turnaround experience, during CREE's October 17 quarterly conference call drove short sale covering and the theoretical pair trade lost -3.04% (+12.55% -15.59% = -3.04%). We continue to believe the pair trade has merit and we are highlighting it once again for November 2017.
Major sell-side revisions to the October 2017 long model
The October 2017 long model of 35 stocks received at least 14 positive sell-side price target revisions and 3 ratings upgrades, led by 3 positive price target revisions to Micron Technology.
Contradicting the long thesis, the long model realized at least 1 negative price target revision and 2 ratings downgrades.
Major sell-side revisions to the October 2017 short sale model
The October 2017 short sale model of 25 stocks received at least 14 negative sell-side price target revisions and 6 ratings downgrades, led by 10 negative price target revisions to Under Armour Inc.
Contradicting the short sale thesis, stocks in the short sale model received at least 11 positive price target revision and 4 ratings upgrades. Integrated Device Technology Inc. (IDTI) led with 4 positive price target revisions.
12-month returns for the October 31, 2016, long model portfolio
Our theoretical model portfolios, which rebalance every month, can also work well as a 12-month idea list.
Last year's theoretical equal-weighted model portfolio (23 Stocks for November 2016) returned 36.8% from the assumed rebalancing date of October 31, 2016, through October 31, 2017. The portfolio outperformed the S&P 500 Index return of 21.1% by 15.7 percentage points.
16 stocks performed better than the S&P 500 and 7 underperformed. In last year's report, we highlighted Vantiv, Inc. (VNTV) as our favorite long idea. VNTV was the 18th best performer with a return of 16.4% over 12 months.
This 12-month buy-and-hold model was composed of the following stocks:
Applied Materials Inc. (AMAT)
Apollo Global Management, LLC (APO)
Teradyne Inc. (TER)
ManpowerGroup Inc. (MAN)
Masimo Corporation (MASI)
Unum Group (UNM)
Regions Financial Corp. (RF)
ING Groep N.V. (ING)
Logitech International S.A. (LOGI)
Lear Corp. (LEA)
Texas Instruments Inc. (TXN)
Copart, Inc. (CPRT)
First Republic Bank (FRC)
Northrop Grumman Corp. (NOC)
VeriSign Inc. (VRSN)
CalAtlantic Group, Inc. (CAA)
Lowe's Companies Inc. (LOW)
Vantiv, Inc. (VNTV)
NetEase, Inc. (NTES)
Cirrus Logic Inc. (CRUS)
United Therapeutics Corp. (UTHR)
American Eagle Outfitters Inc. (AEO)
Vipshop Holdings Limited (VIPS)
Long-running advice regarding the use of our model portfolio report
Wayne Gretzky said it best: “Skate to where the puck is going to be, not where it has been.” Quantitative screens like the one in this report show where a stock has been and assume the trajectory is fixed. Of course, this is not always the case. The best investors will use this model portfolio as guidance, and not the end all. At the same time, the model does well enough on its own, often beating the indices with ease. With a little effort, we hope that active fundamental portfolio managers will do even better.
Except for extremely unusual circumstances, our long model portfolios are composed of high-quality stocks and our short model portfolios are composed of low-quality stocks.
As a simple quantitative model based on fundamental rankings, the portfolio models do not take into account rumors or pending M&A transactions.
Theoretical return data does not assume the impact of costs such as execution fees, margin fees, slippage, the availability of stocks for short selling, or any other kind of cost.
We favor reporting theoretical model portfolio returns data on a simple cumulative basis. Cumulatively adding daily returns allows for the easy comparison of returns from one period to another. Simple cumulative returns are significantly lower than compound returns over time.
Since the March 31, 2009, inception, the theoretical Core Long Model portfolio has returned 195.10% on a simple cumulative return basis and 474.4% on a compound return basis. The S&P 500 Index over that same period returned 127.45%% on a simple cumulative return basis and 222.77% on a compound return basis.
In many cases the models are created just prior to the market close each month.
This report in PDF format here.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: As a simple quantitative model based on fundamental rankings, the portfolio models do not take into account rumors or pending M&A transactions. Theoretical return data reflect simple cumulative returns (not compound returns) and do not assume the impact of costs such as execution fees, margin fees, slippage, the availability of stocks for short selling, or any other kind of cost. There are limitations inherent in our theoretical model results, particularly with the fact that such results do not represent actual trading and they may not reflect the impact material economic and market factors might have had on our decision making if we were actually managing client money. We do our best to provide accurate information in this report, but do not guarantee its accuracy.