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A Simple Value Strategy Beat the Hedge Fund!

The S&P 500 rose 7.6% this month through October 27, the Dow rose 8.0% and the NASDAQ rose 9.0%.
You’d think the financial press would be rejoicing, and congratulating individual investors for holding on through the August stock market downturn, or—gasp!—being wise enough to buy low. Because the market averages don’t just increase by themselves; people need to actually purchase stocks in order for stock markets to rise.

But the media would have you believe that all the talented stock market investors lost money in October, and that it was voodoo that drove the market higher.

In a Bloomberg article this week, Tom Lee, managing partner of Fundstrat, said, “It seems everybody the last month had a five-day period where they got wiped out. You had to be a ninja to come away unscathed during this rally.” Wiped out?!

Shares of Valeant Pharmaceuticals (VRX) fell 33% in three days last week, amid allegations that the company had falsified revenue numbers. Bloomberg reported, “Thirty-two hedge funds counted Valeant among their top 10 holdings.” Seriously. Hedge fund managers were playing “monkey-see, monkey-do,” chasing after the same stocks, and they all got burned.

What on earth does that have to do with real people making prudent investment decisions? Investors who followed my advice made as much as 124% profit on VRX between January 2013 and March 2014, when I warned investors that the balance sheet debt had grown to a prohibitive level, and recommended that they use stop-loss orders. As far as I know, no investors who followed my advice were invested in VRX when the price collapsed last week.

Stock investing is complicated, yes, but it’s a skill that can be improved over time. I have a basic formula, and it works very well:

1. Find stocks of companies whose profits are projected to grow for the next few years.

2. Screen out the stocks with high price/earnings ratios (P/Es).

3. Screen out the stocks with high debt ratios.

4. Take the list of remaining stocks, and buy the ones with bullish charts.

Sure, there are lots of nuances to my stock selection formula, but that’s the basic structure. I’ve also learned not to second guess the variables, because each variable screens out risk. And that’s why I never would have owned stock in Valeant Pharmaceuticals recently.

There are 21 stocks in the Smart Investing in Turbulent Times portfolios, which commenced on October 6. Three of these stocks are down between 1%-4%. The other 18 stocks have risen nicely, because my stock-screening process, combined with a market upturn, worked exactly the way it’s supposed to work. Undervalued growth stocks went up—surprise!

Let the hedge fund managers chase their tails. You and I can ignore them, and focus instead on undervalued growth stocks in our quest for capital gains.

Here’s one.

Expanding into the World’s Largest Cruise Market

Carnival (CCL) is the world’s largest cruise ship operator, serving 4.5 million guests per year. The company owns nine cruise brands, with over 100 cruise ships, cruise support operations, and Canadian and Alaskan tour businesses.
This week, the company announced a commitment for the Carnival Cruise brand to dedicate two cruise ships to the China market. The first will begin service in the spring of 2017, and the second, a year later. Carnival will access the resources and expertise of its sister cruise line, Costa Asia, in the planning and launch of its new China venture.

In total, Carnival will have six cruise ships operating in the China market, via its Carnival Cruise, AIDA, Princess Cruise and Costa Asia brands. Other famous company brands include Cunard and Holland America.

Carnival also announced 40% ownership in a new 25-year joint venture with China’s largest shipbuilder and a Chinese investment company. The venture will establish a multi-ship domestic fleet serving the Chinese market, which is expected to become the largest cruise market in the world. Notably, cruise ticket prices are higher in Asia than in other global locales, which should boost corporate revenue growth.

In addition, the company expects to add another nine new ships to its global cruise brands in 2019–2023.

Industry surveys report higher year-over-year ticket prices and total revenues, along with full ships. The industry outlook remains robust, with strong booking trends in 2016 and 2017 throughout the luxury brands. Carnival reported record revenue of $15.9 billion in 2014. Revenue is expected to grow another 4% in 2015, excluding foreign exchange effects.

Higher revenue, operating efficiencies and lower fuel costs are contributing to Carnival’s expected aggressive earnings growth. Wall Street analysts expect Carnival’s earnings per share (EPS) to grow 32.7%, 27.3% and 15.7% in 2015 through 2017 (November year-end). The 2015 earnings estimate has been slowly climbing for many months now.

And This Aggressive Growth Stock Pays Dividends

Carnival pays a current dividend yield of 2.2%, which is unusual, considering that most aggressive growth stocks don’t pay any dividends at all! The most recent quarterly dividend increase was announced in April 2015, consisting of a 20% increase, which was paid in June 2015. Investors who own CCL shares before the ex-dividend date of November 18 will receive the next dividend on December 11.
The stock’s 2015 and 2016 price/earnings ratios (P/Es) are 20.6 and 16.2, making the stock distinctly undervalued versus its EPS growth rate, and also versus its historical P/E range.

The stock’s 2014 long-term debt-to-capitalization ratio was low, at 22%; down a little from 24% in 2013. This number is important to me, because just as debt can hamstring a household budget, so can it prevent corporations from expanding, hiring, investing in product development, paying dividends and buying back stock.

Carnival’s stock price has exhibited a climbing and resting pattern for more than three years. Last week, CCL traded between 48-53, and this week, the stock showed its readiness to begin climbing again.

The stock price peaked briefly at 57.95 in December 2004, and is just now re-approaching that price, so shareholders should expect some upside price resistance when the stock reaches the upper 50s. On the flip side, any multi-day weakness in U.S. stock markets could pull the price back to 50. If that happens—without any company-specific bad news emerging—I would absolutely buy more shares of CCL. So your near-term trading range is 50–58.

CCL shares have a low degree of volatility. Investors should be aware that there are occasionally cruise ship problems in the news—onboard illnesses, fires, etc.—which could cause the stock price to drop. In addition, travel and leisure businesses are economically sensitive, and likely to attract less business when economic conditions deteriorate. Rising oil prices could impact profitability. You should always consider using stop-loss orders on your stocks to protect yourself from such unforeseen bad news.

I added CCL to my Smart Investing in Turbulent Times Growth & Income Portfolio in early October because it can appeal to aggressive growth investors, value investors and dividend investors. My advice: Buy CCL now, before its next run-up!

Rating: Strong Buy:


Happy investing!

crista huff
Crista Huff

Chief Analyst, Smart Investing in Turbulent Times

Crista Huff is the lead analyst of Cabot Undervalued Stocks Advisor, where she combines a strict fundamental methodology with technical analysis, to identify growth and value stocks whose charts are turning bullish.