Industry Ranks February 2013

My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?” Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled “Dig through.”

If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh? Why change if things are working well? I’m not saying to change if things are working well. I’m saying don’t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don’t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy, some healthcare-related names, particularly those that are strongly capitalized. I’m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

I’m looking for undervalued and stable industries. I’m not saying that there is always a bull market out there, and I will find it for you. But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive. I don’t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting. The red zone is pretty cyclical at present. I will be very happy hanging out in dull stocks for a while.

That said, dull is hard to find these days. Where will demand remain strong, or where will demand rebound are tough questions.

The Red Zone has a Lot of Noncyclicals

What I find fascinating about the red momentum zone now, is that it is laden with noncyclical companies. That said, it has been recently noted in a few places how cyclicals are trading at a discount to noncyclicals at present.

So, as I considered the green and red zones, I chose areas that I thought would be interesting. In the red zone, I picked IT services and beverages. Stable industries.

In the green zone, I picked most of the industries. If the companies are sufficiently well-capitalized, and the valuation is low, it can still be an rewarding place to do due diligence.

That said, it is tough when noncyclical companies are relatively expensive to cyclicals in a weak economy. Choose your poison: high valuations, or growth that may disappoint.

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you. I looked for companies in the industries listed, but in the top 4 of 9 financial strength categories, an with returns estimated over 15%/year over the next 3-5 years. The latter category does the value/growth tradeoff automatically. I don’t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen. Remember, this is a launching pad for due diligence.

Full disclosure: long SPLS, TOT, INTC, VOD

3 Comments

  • Greg says:

    David — thank you for sharing your list. Just curious: while I can see the wisdom in buying good names for the “long term”, do you try to hedge downside risk of the market as a whole? Do you buy index puts and/or inverse ETFs?

    PS — don’t think they are publicly traded, but W.B. Mason is eating Staples alive in New England states. The two Staples stores nearest me are behaving exactly like CompUSA did 5-10 years ago. I am not allowed to short stocks (and your readers should make their own evaluation), but in the spirit of sharing info both directions…

    • SPLS is probably exiting at the next change later this month. They are getting eaten by AMZN in my opinion.

      I offer a hedged portfolio by shorting SPY. If I use options or inverse or leveraged ETFs, my insurance rates would go up.

  • Greg says:

    In the interest of sharing info (ie readers should do their own evaluations), SPLS is essentially three businesses:
    1) consumer retail — this part makes it or breaks it in August / September (back to school sales). The rest of the time the store is a loss leader / glorified warehouse for #2. This part of the business is being destroyed by both Amazon and Walmart
    2) small/medium business sales — this is the high profit margin, year round regular sales. This part is being cherry picked by W B Mason, as well as OfficeMax and Office Depot (two perfect clones of Staples) — none have any competitive advantages except lowerprice / lower profit margins.
    3) services — copy center, computer tech support, consumer package shipping, etc. This seems like a pure loss area with much stronger competitors — FedEx Kinkos, UPS store, etc. If you are a traveling salesperson, both FedEx and UPS will print your documents and deliver to your hotel / presentation … Staples can’t do that. Tech support: have you tried rebooting?

    At least by my understanding, business #2 (direct sales to businesses) is the highest profit margin business — SPLS is getting eaten alive.

    Consumer business is suffering from low traffic, lots of shop lifting, a staff that treats all customers as though they are shop lifters (which alienates legitimate customers), and poor inventory control. Back to school sales are going to Amazon and Walmart.

    I would be shorting SPLS if my investment mandate would permit it (I am prohibited). Staples are making all the mistakes of CompUSA, and will likely end up in the same Chapter 7 courthouse.

    Again, all readers should do their own analysis — just sharing for whatever it is worth. Some stocks are cheap for a reason

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