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Friday, October 04, 2013

Investing Michigan Style

As I have mentioned in the past I am something of a geek. Once I finished running stock screens and checking the stocks in my portfolio for any important fundamental changes I turned to serving business school websites for interesting new papers or research article that might contain significant information that would help us as investors. I found a few on interest and will report back on them after I have digested them but at the University Of Michigan Webster School Of Business I found something that interested me greatly and should you as well. They are running two portfolios that are posted on the website identifying stocks that are undervalued and another one that lists what they call earnings torpedoes.

Earnings torpedoes are stocks that the students have identified as having the potential to blow up as a result of poor earnings. They use academic theories such as earnings quality, cash flows, momentum and valuation to identify stocks that could be set to sink your portfolio.  I checked through the historical lists they keep on the site and the theory actually worked very well at finding potential disasters and torpedoes underperform the market much of the time. I have mentioned more than few times I am cautious about the markets and sometimes the best way to make money is to lose it so the list is worth a review to see where danger may lurk.
The list is littered with energy related Mater Limited Partnerships (MLPs). Many of these oil and gas collection, transmission and storage partnerships have been bid up to very high levels as a result of strong oil prices and indiscriminate yield seeking by investors. Billions of dollars have flooded into the sector as ETFs and funds were formed to take advantage of the higher yields offered by these vehicles. Some of the better known MLPs that are potential torpedo stocks include Atlas Resource Partners (ARP),Atlas Energy (ATLS),  Cheniere Energy Partners (CQP) and Eagle Rock Energy Partner (EROC). Investors who own these names may want to review their holdings and consider lightening up on the shares.

The list is absolutely dominated by small cap biotech stocks.  50% of the list is biotech’s like ARIAD(ARIA), VIVVUS (VVUS) and  Idenix Pharmaceuticals (IDIX). Biotech has been red hot this year with the industry indexes and ETFs up more than 30% but investors might want to get some money off the table. I have ling maintained that this is an incredibly specialized filed and if you don’t possess, or have an advisor who possesses, a medical degree with a biotech concentration, small biotech’s are a danger zone for individual investors. Using traditional fundamental or technical analysis techniques on these stocks is a game of financial Russian Roulette in my opinion. If you own individual small biotech’s it is worth your time to go the schools website and see if you are hanging on to a potential torpedo stocks.

There are some big market darlings on the list that momentum investors need to be aware of before you take a torpedo amidships to your net worth. has shown up on several of my red flag lists in recent weeks even as the stock has run higher in recent weeks. With a forward earnings estimate multiple of 100 times the slightest disappointment form this company is going to cause an implosion in the share price and all but the most nimble of traders should probably avoid the stock at this level. Zillow (Z) is another trader favorite that has had a nice run as housing markets have recovered somewhat but it is now on the danger list. At more than 150 times estimated profits it would not take much bad news to explode the stock and your portfolio along with it.

It is worth your time to check out the torpedo list on the Webster Business school site. Even if you decide you do not agree with them on certain stocks or sectors it is thought provoking and educational. Next I will take a look at the stocks the students have identified as undervalued and see if we can find any potential gems to buy.

. The folks at University of Michigan Webster School of Business not only has a list of stocks you should avoid they have one that gives you 40 stocks they think are undervalued. They do not reveal exactly which metrics they use but the website says they use Value, Momentum, Quality and Predictability. It is a combination of several of the more successful academic theories and it producers a really interesting list of stocks that might appeal to ling term investors. According to the site the screen has beaten the market handily in 8 of the last 10 years.

It is easy to see that momentum and value are heavily weighted in the 40 stock list as many of them are former deep value stocks where the price has begun to improve. It was no that long ago that basset Furniture traded at a fraction of book value and was wildly out of favor on Wall Street. The company is firing on all cylinders now with three quarters in a row of strong sales growth and the stock is now at a small premium to book value. Insiders have been buying stock outright and exercising options and keeping the stock so that’s another academic theory at work in this stock. The company has plenty of cash and little debt and seems to have put the recession in the rear view window. Basset is doing much better than many other consumer related companies right now.

They have a few little banks as well which comes as no surprise to me at all. I will highlight two from opposite ends of the bank spectrum. Monarch  Financial Holdings (MNRK) is a little bank  with 11 banking offices, 15 residential mortgage offices, and 1 investment services office in the Norfolk /Virginia Beach area. It also operates 2 full-service banking offices and 2 residential mortgage offices in the Outer Banks of North Carolina, as well as 28 additional residential mortgage offices outside of its primary banking market area, The bank is in great shape with  nonperforming assets of .29% of all assets and an equity to assets ratio of more than 10. The stock trades at 1.2 times book value and has momentum on its side with the share up almost 40% this year.

Parke Bancorp (PKBK) is on the other end of the spectrum. The New Jersey bank has 6 offices in in its home state and one if the greater Philadelphia area and about $740 million of assets. The stock is much cheaper than Monarch at 75% of book value and there is a good reason. The loan portfolio is a mess with non-performing loans at more than 7% of total loans and nonperforming assets at a staggering 9% of total assets. They do have excess capital with equity to assets ratio of a little over 13 but asset quality has been slow to improve. This one has more a long shot feel to it but if they do succeed in getting their house in order the upside could be huge.

There are also lots of small insurance stocks on the list including one, Eastern Insurance Holdings (EIHI) that announced a takeover bid yesterday at a pretty big premium. This stock was one of my top picks for 2011 and has more than doubled thanks to the acquisition offer. This is going to be repeated throughout the industry over the next few years as smaller life and property and casualty insurance companies are very cheap compared to historical valuation level. It is worth your time to go to the schools site and run through the insurance picks stock by stock.

For fans of sin stocks Ricks Cabaret (RICK) makes the grade as a University of Michigan cheap stock. The only publicly traded operator of Gentleman’s Clubs. The stock trades at 12 times earnings and 1.27 times book value and business is apparently pretty good. The CEO and CFO like what they see as much as the customers as they have been buyers of the stock over the past few months.

Star Gas (SGU) makes the grade as well as this remains one of my favorite little long term income stocks. The propane company is not going to set anyone’s portfolio on fire but it will continue to roll up Mom and Pop propane dealers and pay a strong dividend. The stock yields 6.75% and is a good fit for most income investors in addition to the schools value stock list.

Tracking the academics makes a lot of sense to me. When they have proven they can outperform and are willing to publish their stock lists as Michigan has it makes even more sense to check the page regularly.

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