Can Ugly Stocks Soar Your Returns?

Whew! What a run!

It’s been breathtaking to see stocks rocket higher in 2018 with almost no selling pressure. It’s the hottest start in decades, investors are scrambling to catch up, and stock and bond exchange-traded funds have seen average daily inflows of $3.3 billion in the first eight days of trading in 2018.

That’s a mind-blowing amount of buying.

Individual investors aren’t the only buyers. Corporations have stepped up their buyback programs – in December, corporate buybacks hit a six-month high at nearly $100 billion. Big buybacks have been a key driver of this bull market since 2009, and at this point it’s a requirement to propel the markets higher.

But the question remains, are investors piling in too late? To say that market valuations are stretched would be an understatement. Take, for example, the median pricetosales ratio on the S&P 500. It’s at the highest level. Ever.

Back in 2009, when we were coming through the financial crisis and the market was bottoming, you could have picked up the S&P 500 for 0.8 sales. That’s a reasonable level to buy a dollar of sales for less than a buck. It also represented the cheapest level in about 17 years.

Today, you’re paying 2.63 times revenue. That’s rich. And it’s not because sales growth in the S&P 500 is rocketing to the moon. There hasn’t been a double-digit growth rate in a decade. In 2015 and 2016, revenue growth was negative. Yet the market has been in an unrelenting uptrend.

As you would expect with a market that rises nearly every day, investor sentiment has become extremely bullish. One of my favorite polls is the Ned Davis Research (NDR) Crowd Sentiment Poll because it’s a collection of various market sentiment gauges and provides a good sense of market sentiment among different investor groups.

Currently that NDR poll is at 78.9, which is not only a clear sign of extreme optimism” but also the highest level ever. As an investor, you want to act contrary to the group view on the market, so extreme optimism is a scenario where you want to act defensively with respect to your investments. Right?

Of course, none of this has mattered.

The market has also hit records of low volatility and lengths of time with no meaningful pullbacks. We’re in uncharted territory. These warning signs won’t matter until they do. While the markets change and the factors driving the markets change, human nature never changes.

Right now we’re lulled into a sense of complacency. When that changes, it’s going to get nasty.

But there is a stock out there that’s already gotten a beating and hasn’t enjoyed the huge upward trajectory that’s taken hold of pretty much everything else. In fact, my research once identified this company as one as the worst stock among the 500 largest publicly traded companies in the United States.

Thing is, when you’re at the bottom, there’s only one place to go, and that’s why I’ve selected this stock as this month’s Hidden Profits recommendation. Sometimes ugly stocks make for great investments. After getting hammered, things appear to have bottomed, and improving fundamentals will lead to big margin and cash flow benefits and the stock can trade much higher from here.

This company now has so much room to run, and so much cash flow in its future, that it’s set up to reward investors for the long haul. Wall Street is still bearish on this stock, so we have the chance to get in well before anyone else does. It’s clearing out inventory, investing in important new technologies, and it’s well on its way to doubling or even tripling operating margins.

This is a play for the back half of 2018 and beyond. Read the whole story here.

Good investing,

John Del Vecchio
Editor, Hidden Profits

This post was originally published on Economy & Markets and can be seen here.

Similar Posts