Avoiding Losers And Finding Long-Term Winners

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Includes: GE, KHC, LMT, MA
by: Mark Bern, CFA
Summary

Investors do not control this market; traders do.

Avoiding losers.

Identifying long-term winners.

We remain cautious in a turbulent market.

Thursday’s headlines:

Algorithms and HFTs (High Frequency Traders) In Control

We have seen this type of news many times before and it just spurs wild roller coaster market trading. Markets have been having these wild swings because trading algorithms (not individual investors), which now account for 80% of the daily trades in the markets, are linked directly to news agency headlines and twitter feeds using computers to react instantly with billions in funds. So, basically, one day you might see the Dow 30 down 385 points and then get a two-day reversal of two 250-point days. For these machines it's like taking candy from a baby as they control about 80% of the trades; so if you are controlling 80% of the trades, you can make money no matter what happens since your systems instantaneously either go long or short in 100th's of a second with billions and not just in the US markets, but globally.

Now, obviously we cannot compete against these machines by playing their game as even mighty multi-billionaires like Warren Buffett (now holding over $120 billion in cash) have had billions in losses due to these trading algorithms shorting poor investments he made in companies like Kraft Heinz (KHC), for example.

Source: Google Finance

The secret to this game is buy elite companies with elite management at the helm, which clearly Warren Buffett did not with KHC and is paying dearly as are those individual investors who have stubbornly owned General Electric (GE).

Source: Google Finance

GE is a very similar story of terrible management at the helm.

Avoiding Losers

We avoid such investments as we have an algorithm of our own called Friedrich, which would have shown us the following two datafiles of KHC and GE.

Source: Friedrich Global Research

Source: Friedrich Global Research

Clearly, both are all red and filled with warnings. When warning signals are flashing, it is best to stay away.

Identifying Long-term Winners

With the help from Friedrich, we are thus able to operate far from Wall Street and only go there when Friedrich finds us something attractive to buy as it did with our superstar stock Mastercard (MA).

Source: Friedrich Global Research

Mastercard this week hit an all-time high, and using the same charting methodology as used above, you can see that the last five years has allowed us to do very well owning MA.

Source: Google Finance

Mastercard is so insanely profitable because it just handles transactions for billions of consumers every day. Whether it’s a debit or credit card, if you use either, MA gets a cut, but the beauty is that it does not use its own money like American Express (NYSE:AXP) does when you make a transaction, but instead is affiliated with banks who take on the risk. All MA does is handle the transaction and get a tiny cut of the action. The beauty is that as more and more people move away from using cash and use more plastic, MA will continue to grow. The future of such a movement is still in its infancy as consumers in India and China with their billions of citizens are only now starting to use credit and debit cards.

Another company that is dominating the world is Lockheed Martin (LMT). They sell futuristic fighter jets called the F-35 and these jets are so advanced that they can shoot other planes down while remaining outside of the enemy’s radar range. Each of these planes sells for about $100 million and just the pilot helmet costs $400,000. You would think that countries would balk at such a high price, but countries have been lining up in droves to get their hands on them and, not only that, but the Navy, Air Force, Army and Marines each have declared the F-35 the main fighter for the USA fighting forces. Now, with some 4,000 orders at $100 million each, that equates to $400 billion in future revenues, but then when you add the parts and service contracts going out to 2040, we have close to $1.5 trillion in revenue just from the F-35 fighter program. If you notice from the data below that Lockheed Martin only has a market capitalization of $110.5 billion even though like Mastercard it is at an all-time high, it becomes a no brainer, as it too is a toll collector of sorts with built-in future revenue.

Source: Google Finance

And that is why Friedrich gives it an $851 sell price.

Source: Friedrich Global Research

The above two examples show consistency and superior results over time. Add to that a great business model with competitive advantages and you have winners that can weather the occasional economic storm and provide growth over the long term.

We are not value or growth investors but are Friedrich investors which means buying companies with elite management and elite market dominating products/services. We also invest on Main Street and only buy on Wall Street when we can find long-term bargains.

Thus, we can afford the luxury of keeping some dry powder in cash just in case the markets fall off the rails instead of just riding the wild roller coasters.

Caution Still Warranted Until We Get Some Answers

The markets were way down on Tuesday and then have recovered on Wednesday and Thursday based on news that the USA and China will start trade talks again. But, as we have seen more times than we can count, one negative Presidential twitter feed over the next three weeks and all will go down the drain again. Clearly, President Trump is not happy with China as this data shows.

About a year ago we said our biggest worry was a trade war and it continues to still be our biggest concern. We are waiting for an actual document to be signed before jumping in because talk is cheap, and unless official trade deals are signed, we will not believe the rhetoric as this story changes on a daily basis. Clearly, President Trump is still angry and could double tariffs overnight if he wanted to. So that is still a major concern.

Another major concern is the United Kingdom and the problems of Brexit from the EU. Prime Minister Boris Johnson is a serious gambler and is causing all kinds of chaos in the UK which could cause some serious problems in the EU. Johnson is calling for an early election which could make him the shortest serving PM in history, 6 weeks in power and he is calling for a pre-Brexit national election.

Whether he will get it or not is still up for debate, but it is a serious gamble. The EU is watching all this and feels that it holds all the cards due to the chaos in the UK right now and thus refuses to negotiate, but if the UK PM were to get a general election and were he to win, he could force a nasty Brexit that could send European markets spiraling which would also affect the global markets, as well.

Nothing has changed as of yet, but over the next few weeks, we could have some kind of indication on both the trade front with China and as to whether it will be a clean or dirty Brexit. Those jumping back into the markets now are gambling and we do not gamble, but in the meantime, continue to hold some wonderful stocks that are very long-term investments based on elite management and superior products/services. Those can carry us through the next few weeks until we have some answers.

If all works out well with successful US-China trade talks and the Brexit problems are solved to everyone's satisfaction, we could invest more into the market. We are not alone in staying cautious as Sam Zell, one of the greatest investors on the planet, is also cautious and will close here wishing you a good fortune as you read the following Sam Zell quote who just went to $3.2 billion in cash.

"We certainly never had a cash position like we have now. I think we’re very reticent about the opportunity. We think there’s gonna be some significant opportunities, but what we don’t see is the urgency."

The opportunities should become evident once we have some answers. Buckle up; it’s going to be a crazy ride for a while longer.

Disclosure: I am/we are long MA, LMT. 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:
DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from our research. Factual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.