Investment Strategy Statement - GS Analytics

by: GS Analytics
Summary

I primarily cover small- and mid-cap industrial and consumer stocks.

In addition to valuations, I often look for catalysts that can unlock value/move stock price in short to medium term.

My long-term objective is to beat S&P 500 by 15% to 20% per annum, consistently.

My primary investing focus is in U.S. industrial and consumer stocks, most often in the $200 million to $10 billion range. I began my career as a generalist covering cyclicals for a small New York-based hedge fund (~$200 mn in assets) and have followed the companies in transportation, housing, general industrial, and consumer sector for over a decade. In addition, I also cover equity REITs and services sector. While my focus is on value and GARP opportunities, I often look for catalysts that can unlock value/move stock price in short to medium term.

Investment Process

My investment process includes going through the latest SEC filings, conference call transcripts, speaking with management/competitors, and performing channel checks to get a better understanding of the company's business. I also look at sell-side reports to get a sense on what market is pricing in and if investors are significantly underestimating or over-estimating a company's prospects.

I use bottom-up approach for idea generation. I often scan through 4-5 companies a day to identify possible investment candidates and then take a deep-dive in the companies I find interesting.

Ideal Long/Short Candidates

An ideal long idea for me will be a good company available at reasonable valuations with catalysts to unlock value and drive stock price upward. On the short side, I look for broken business models/overlooked risks with catalysts like earnings miss to drive the stock price downwards.

Valuations Approach

I use both relative valuation and DCF approach for valuations. For relative valuation, I compare the company's valuation to its historical peak and trough multiple and account for where we are in the cycle. I also look for factors which can help a company achieve better multiple with respect to previous cycle. For example, one of my current ideas is Masco Corporation (MAS). The company has significantly reduced its new construction exposure over the last decade and deserves a better valuation due to lower cyclicality. Market isn't accounting for this lower cyclicality making it a good buy. In addition to comparing a company's current multiple with historical peak/trough, I also look for the company's multiple and growth prospects with respect to its peer group while performing relative valuation.

DCF method is a bit tricky when it comes to cyclical stocks and it is only as good as your projections. I often find sell-side analysts projecting continued growth even during late cycle stages and using these growth rates and high terminal value to justify stock price targets. Sometimes, it is very obvious that they are tweaking their estimates only to justify the current price, completely ignoring cyclicality of the business. I believe such situations represent opportunity to short the stock. Similarly, sell-side analysts often miss cyclical bottoms and their estimates go too conservative when a business is seeing cyclical declines. That represents a good buying opportunity. For terminal value, I like starting with mid-cycle earnings potential and then account for secular growth aspects, if any, of the business.

Risk Management

I find it better to leave risk-management to an algorithmic approach rather than applying my intuition. Over the last few years, I have been working on developing a quant-based approach for portfolio risk management. While I am still fine-tuning it, I believe it will be ready for deployment in 2019.

I often classify my stock picks in two categories - tier 1 and tier 2 - based on the level of conviction I have on them and use that as one of the inputs to decide the level of allocation. I believe 6-8 ideas per year where I have strong conviction are much better than 30-40 ideas with medium level of conviction.

One of the hardest investment lessons I learned was from placing a bet on BHP Billiton (BHP) and Potash Corp merger in 2010. I strayed away from my core-expertise of identifying undervalued/overvalued ideas with near- to medium-term catalysts and paid a heavy price. So, I prefer not to deal in areas outside my core expertise in order to minimize risk.

Portfolio Returns Objectives And Industry Expertise

My objective is to generate alpha returns, and if there is a stock which can give more than 20% return over the benchmark, I will consider including it in the portfolio. Similarly, on the short side, if a stock can underperform the market by more than 20%, I will consider shorting it. My long-term objective is to beat S&P 500 (SPY) by 15% to 20% per annum consistently.

I have been following industrial and consumers stocks closely for over a decade. So, I believe I have an edge when it comes to understanding their businesses and macroeconomic trends impacting them and some of my best ideas are from these sectors.

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.