“A falling stock price doesn’t mean the stock is cheaper; it doesn’t mean that the stock will go back up; and it certainly doesn’t mean that the stock can’t fall further. In some cases, a falling stock can become more expensive as it drops, if its value falls by a greater amount.” – Brian Nelson, CFA
The company formerly known as Google, Alphabet (GOOG, GOOGL), is surging in after-hours trading February 1. As a result of Google’s stock split in 2014, we include both share classes (non-voting Class C, GOOG, and Class A, GOOGL) in the Best Ideas Newsletter portfolio, collectively one of its largest holdings (5%+). Alphabet, then known as Google, first registered a 10 on the Valuentum Buying Index October 2012 at $320 per share. After hours, GOOG is indicated up ~5%, to $791 per share, while GOOGL is indicated up ~4.8%, to $808 per share. You may have already heard: Google is now the largest company on the US exchanges, surpassing Apple’s market capitalization.
In its fourth-quarter report, Alphabet revealed accelerated revenue growth in the period, to 24% on a constant-currency basis, versus the 18% mark in last year’s period. GAAP and non-GAAP operating income and margins advanced in the quarter, and management was upbeat about “mobile search as well as YouTube and programmatic advertising.” GAAP and non-GAAP net income performed well, and the search giant recorded $8.67 per diluted share in earnings, beating the consensus number by nearly $0.60. Alphabet cut back on capital spending in the quarter ($2.1 billion versus $3.6 billion), helping the company generate an impressive $4.3 billion in free cash flow, which bested the $2.8 billion level in the prior-year period. The company ended 2015 with $67.8 billion on a net cash basis.
You don’t have to tell us, but it has been a ho-hum past few weeks for Best Ideas Newsletter holdings given Apple’s (AAPL) and General Electric’s (GE) quarterly performance, “Apple Will Go Lower… And It Will Be ‘Forced’ Into Acquisitions,” “General Electric’s Results Remain ‘Messy,’” and general malaise at recently-removed Gilead (GILD), “Alerts: High-grading! GILD–>JNJ; EBAY–>FB,” which incidentally reports tomorrow after the close, but we like the after-hours action in Alphabet in any case. Sure, Visa (V) and PayPal (PYPL), two other Best Ideas Newsletter portfolio holdings, have been bright spots, but we admit some of our recent ideas haven’t been performing as well as we would have liked, and that includes Alibaba (BABA) and Rio Tinto (RIO), stocks recently removed from the portfolio, “Alerts: Seeking to De-Risk the Newsletter Portfolios.”
It’s important to keep everything in context of the newsletter portfolios, however. The extra kick for us to add companies such as Gilead or Alibaba to the Best Ideas Newsletter portfolio–which at the time was running at ~30% cash with several defensive names, including Altria (MO), Republic Services (RSG) and the Utilities Select Sector SPDR (XLU), for example–was in part to capture incremental “beta” in what was then a very strong market. Without the existing constituents and large cash position in the Best Ideas Newsletter portfolio, we may not have stretched for that “beta” at that time and in those names in particular. In many cases, individual ideas may not always work out as planned (mostly due to a weaker market), but it’s also worth noting that the Best Ideas Newsletter portfolio just hit an all-time high of relative outperformance to the S&P 500 (SPY) a couple weeks ago January 15, “.” The process is working.
This is not obvious at times, but it’s also worth emphasizing that the ideas we select for the newsletter portfolios should be viewed in a portfolio management setting, as in the changes that we make to the Best Ideas Newsletter portfolio and/or the Dividend Growth Newsletter portfolio. Said differently, if we had to pick one stock individually, something that makes little sense in the way of diversification, it almost certainly would be different than those that we incrementally add to the newsletter portfolios, which are done at times for strategic or tactical reasons. We’re working to achieve the newsletter portfolio goals, and sometimes we may accept the probability of losses to do so. We’re hoping you’ll see, for instance, how little sense it would make to call us “wrong” in removing Gilead if it ends up having a great quarter tomorrow when the Best Ideas Newsletter portfolio itself is doing so well. Now if Gilead “blows” up… well that’s a different story. Do you see the risk-reward from a portfolio manager’s standpoint?
There was also another topic that arose recently in the context of how we apply the Valuentum Buying Index. We generally like to add equities to the portfolio when they register a 9 or 10 on the VBI and remove them when they register a 1 or 2, but we do make exceptions at times. For one, the market has been under pressure for most of 2016 thus far, pressuring VBI ratings almost indiscriminately. As a result, we may have to stretch the VBI criteria a bit to achieve newsletter portfolio goals, as in the case of swapping in Johnson & Johnson (JNJ), now a 6 on the VBI (was a 3), “” and swapping out Gilead, now a 3 on the VBI (was a 6), “.” The Valuentum Buying Index is used as one of many factors to achieve portfolio goals, and sometimes we may have to relax it a bit to retain desired exposure to a certain sector, which was healthcare in this case due to its defensive characteristics.
Always remember that valuation is as much of an art (forecasting, range of outcomes) as it is science (financial statement analysis, accounting), and that market prices have information in them, sometimes valuable info. A falling stock price means nothing more than the view that investors believe the stock’s “true” intrinsic value is lower than the previous price. A falling stock price doesn’t mean the stock is cheaper; it doesn’t mean that the stock will go back up; and it certainly doesn’t mean that the stock can’t fall further. In some cases, a falling stock can become more expensive as it drops, if its value falls by a greater amount. Those that like to scoop up falling stocks may get lucky and pick a bottom, but it’s not a likely proposition, and if the stock is undervalued and still falling, the chances are growing that it may turn into a value trap or that the risks to the valuation equation have increased. This is what we encountered with respect to both Gilead and Alibaba as of late, and why we backed away from the “cliff.”
Learn to like stocks that are going up. It just means that the market thinks the stock is worth more than where it is currently trading… that’s a good thing.