- I bought 19 S&P 500 stocks during the March sell-off.
- This article is an update on one of those stocks: Hologic.
- I share my buy, sell, and hold prices for the stock, as well as share the basic process for my analysis, and potential exit strategy.
- Looking for a helping hand in the market? Members of The Cyclical Investor’s Club get exclusive ideas and guidance to navigate any climate. Get started today »
I have two primary methods of sharing my investing ideas and strategies on Seeking Alpha. The first method is via public articles like this one, and the second is via the Cyclical Investor's Club (technically, the blog on SA is a third, though I rarely write articles there). Since launching the Cyclical Investor's Club on 1/12/19, I've always tried to strike a reasonable balance between my public ideas, which everyone can read for free, and the private ideas, shared in the CIC. Over time, I have decided to break these ideas into two distinct categories, where ideas about stocks that comprise the S&P 500 are made public and all the rest remain private. I've tried to abstain from first sharing an idea in the CIC, and then, after the price has run up, sharing it with the public, because I simply didn't like the way it felt to me ethically.
The recent market dive happened so quickly, however, that there was no way I could write public articles in time for all the stocks I purchased March. From February 28th through the end of March, I purchased 33 stocks (plus suggested members buy Berkshire Hathaway (BRK.B, BRK.A), which I already owned), and most of the stocks were purchased in the five trading days nearest the bottom of the market's dip. I could barely keep up with the purchases via the real-time chat function in the Cyclical Investor's Club, much less write full public articles about them all. Of those 34 stocks, 19 of them were components of the S&P 500, and I only managed to write about one of them publicly - Comcast (CMCSA) - at the very beginning of the downturn. So, 18 stocks remain that I plan to write public articles about over the coming weeks. Most of these stocks will no longer be "buys" at their current prices, but I will share both my "buy price" and my "sell price" for the stock in each article so that if we have a double-dip, readers will know the prices at which I think the stocks are buys. And if the market rips higher, readers will know the initial threshold at which I would consider selling and taking profits.
Today's stock is Hologic (NASDAQ:HOLX), and it's one I've done quite well with since purchasing on 3/18/20.
What I'm going to do in this article is to take everyone through my valuation process. It's the same process I use for almost all stocks that have low-to-moderate earnings cyclicality, and it is the process that helped me identify the value in Hologic even though I didn't know much about this business at the time I purchased it.
Step 1: Determine the cyclicality of earnings
On the F.A.S.T. Graph above, the adjusted operating earnings for HOLX is represented by the shaded green area. In the early 2000s, HOLX wasn't profitable yet, but once it became profitable around 2003, earnings rose almost every year, only declining -1% in 2009 and -4% in 2014. Basically, this company has been as steady an earner the past 17 years as many well-known "blue-chip" companies people have been flocking to the past year or two.
The black line in the graph represents the price of the stock. Interestingly, it traded at very high valuations going into the last recession, and peaked with a P/E ratio of about 33 in 2008. During the 2008/09 recession, the stock price lost a whopping -73% off its peak, even though earnings only fell only -1%. This is indicative of a classic sentiment cycle (I've written a lot about them this past year), when earnings themselves are not cyclical at all but the market sentiment surrounding the stock is.
With relatively steady-earning businesses like this, fairly traditional valuations using P/E ratios and earnings growth estimates work reasonably well to predict future returns, so that is what I used for HOLX (if earnings had been more cyclical, I would have used a different method of valuing the stock).
Step 2: Full-Cycle Analysis
Next, I'm going to run what I call a "Full-Cycle Analysis", which is the same analysis I performed that flagged HOLX as a Buy in March. As part of the analysis, I calculate what I consider to be the two main drivers of future total returns: Market Sentiment returns and Business returns.
In order to estimate what sort of returns we might expect over the next 10 years, let's begin by examining what return we could expect 10 years from now if the P/E multiple were to revert to its mean from the previous economic cycle. I start the previous cycle around 2007, about a year before the last cyclical peak.
As I write this, Hologic's forward P/E is 19.29, while its normal P/E this past cycle has been 17.25. If, over the course of the next 10 years, Hologic's P/E were to revert to its normal 17.25 level and everything else was held equal, it would produce a 10-year CAGR of about -1.11%. (My minimum threshold for purchasing a stock during the current recessionary downturn is a +1.00% expected 10-year CAGR from sentiment mean reversion, which this stock had when I bought it. However, the price has risen a lot since then, and now the expected returns from mean reversion are negative.)
Step 3: Current and Historical Earnings Patterns
We previously examined what would happen if market sentiment reverted to the mean. This is entirely determined by the mood of the market and is quite often disconnected, or only loosely connected, to the performance of the actual business. In this section, we will examine the actual earnings of the business. The goal here is simple: We want to know how much money we would earn (expressed in the form of a CAGR %) over the course of 10 years if we bought the business at today's prices and kept all of the earnings for ourselves.
There are two main components of this: the first is the earnings yield, and the second is the rate at which the earnings can be expected to grow. Let's start with the earnings yield.
Hologic's forward earnings yield is currently +5.39%, according to YCharts. I have a couple of things to point out with the earnings yield. The first is if you look at the chart, you will see the point where the earnings yield surpassed 9%, and having a 9% expected 10-year business CAGR was one of the recession thresholds I had in place when purchasing stocks during the downturn. So, even without taking earnings growth into account, we can see Hologic, for a few days, was providing an earnings yield over that threshold.
The way I like to think about this is, if I bought the company's whole business right now for $100, I would earn $5.39 per year on my investment if earnings remained the same for the next 10 years. (Back in March, this number was over $9.00, so you can imagine the dramatic difference it makes buying at a lower price in terms of the expected return on investment one gets.)
The next step is to estimate its earnings growth during this time period. I do that by figuring out at what rate earnings grew during the last cycle and applying that rate to the next 10 years. This involves calculating the EPS growth rate since 2007, taking into account each year's EPS growth or decline, and then backing out any share buybacks that occurred over that time period (because reducing shares will increase the EPS due to fewer shares).
Let's start by looking at how much shares were reduced since 2007.
These guys increased shares way back in 2007, probably for an acquisition or something. If this acquisition would have only been a couple of years ago, I would probably have avoided the stock, but since it has been a decade and the business seems to be doing fine, I'll just move the chart up to a post-acquisition time frame.
From January 2008 through today, shares outstanding haven't changed much this cycle, but we have seen more recent buyback activity. Overall, there is not much to adjust for here, and when I go back to 2007 through today, I get a cyclically adjusted earnings growth rate of +7.72%, which is a pretty good growth rate over this period.
Next, I'll apply that growth rate to current earnings looking forward 10 years in order to get a final 10-year CAGR estimate. The way I think about this is, if I bought Hologic's whole business for $100, it would pay me back $5.39 the first year, and that amount would grow at +7.72% per year for 10 years. I want to know how much money I would have in total at the end of 10 years on my $100 investment, which I calculate to be about $183.00. When I plug that growth into a CAGR calculator, that translates to a +6.23% 10-year CAGR estimate for the expected earnings returns.
10-Year, Full-Cycle CAGR Estimate
Potential future returns can come from two main places: market sentiment returns or earnings returns. If we assume that market sentiment reverts to the mean from the last cycle over the next 10 years for Hologic, it will produce a -1.11% CAGR. If the earnings yield and growth are similar to the last cycle, the company should produce somewhere around a +6.23% 10-year CAGR. If we put the two together, we get an expected 10-year, full-cycle CAGR of +5.12%.
My Buy/Sell/Hold range for this category of stock is: above a 12% CAGR is a Buy, below a 4% expected CAGR is a Sell, and in between 4% and 12% is a Hold. Right now, Hologic is still in the "Hold" category based on its forward earnings expectations, but if the price rises much higher, thereby pushing the expected CAGR down lower, it will cross the 4% "Sell" threshold. I estimate that would occur if the price of the stock rose above $57.30 per share. As I'm finishing up this article the price stands at $52.01, so another 10% rise from here would push the stock to a "Sell".
It's perfectly fine for an investor to sell as soon as a stock crosses the "Sell" threshold, but often when stocks cross my "Sell" thresholds they have a lot of upward momentum that continues to push the stock price even higher. In an effort to ensure that I don't sell at a price much lower than $57.30 and to try to capture as much upside as possible, I will probably wait for the stock to rise an additional 10% beyond this threshold and then put in a trailing 10% stop. If the momentum takes the stock higher and it stays there, that's great. If it comes back down to about $57.00 and I get stopped out, that's fine, too. I will have made a healthy profit, and the forward expected returns would have been pretty low at that point anyway.
Hologic is a fairly representative example of the stocks that I bought during the dip. Even though Hologic is part of the S&P 500 index, it is an undercovered stock. It has been a full two years since a Seeking Alpha article was written about it. Yet, it stands to potentially provide close to a 100% return for investors who bought during the dip. While there aren't tons of stocks like this around, there were a couple of dozen that were truly on sale in March. My buy price for Hologic is $29.80 if we should have a double-dip, which still has a reasonably high probability of occurring, so consider putting this one on your shopping list.
If you have found my strategies interesting, useful, or profitable, consider supporting my continued research by joining the Cyclical Investor's Club. It's only $29/month, and it's where I share my latest research and exclusive small-and-midcap ideas. Two-week trials are free.
This article was written by
Cory Cramer is an award-winning political scientist and a long-only cyclical investor capitalizing on market cycles. He has been investing since the 1990s and still invests his own money in the companies he writes about.Cory leads the investing group The Cyclical Investor's Club where he shares his unique approach to estimating the fair value of stocks by capitalizing on downcycles for undervalued companies. He teaches 4 unique cyclical strategies, offers a master valuation spreadsheet, and is available to answer any questions via chat or direct message. Learn more.
Analyst’s Disclosure: I am/we are long HOLX, BRK.B. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.