The Largest Valuation Gap in 70 Years

CNBC writes about the current gap between cheap and expensive stocks. This is called the valuation gap and it is historically large. The last time there was such a difference between the high flyers and the lowest echelons of the stock market was when Harry Truman was President, the world was ravaged from World War II, and the Korean War was brewing.

For investors struggling to find opportunities after a stellar rebound in the aging bull market, value stocks might be the best bet.

Case in point: Cheaply priced stocks are getting cheaper as expensive stocks have gotten extremely pricey, pushing the valuation gap to the widest in 70 years, according to AB Bernstein. The record dispersion puts cheap equities in a sweet spot as other pockets of the market start losing the appeal because of their high prices.

What the analyst emphasizes is that the best time for buying value stocks is the point at which valuations have been spread out the most. Many analysts have commented that this must recent upsurge in the stock market is certainly not being driven by value and fundamentals as earnings are getting worse and growth projections in the USA and abroad are not very positive.

What CNBC says is from a technical perspective as they look at value stocks as a technical factor. It turns out that when valuations surge to extreme levels, the value stocks whose prices have been left behind tend to outperform in the coming six to twelve months.

Of course, for long term value investors, when fundamental analysis of a stock shows value and the price is low, this becomes a historic buying opportunity.

Unique Investments in Industry “Disruptors”

In this case, we take a look back a couple of years at Trade Desk which was selling for $29 a share after its IPO in September of 2016 and was trading at $49 as recently as May of 2018. Since then the stock has taken off and is pushing $200 a share today. When are cheap investments the best investments in cases like Trade Desk? It is when they change how things are done in an industry or even create entirely new sectors. When this happens it often takes insight more so than analysis of fundamentals to get in when the valuation is still cheap. But, companies like Microsoft and Apple were similar stories back in the day and have routinely offered buying opportunities along the way.

Doing Your Homework on Cheap Investments

Yahoo Finance looks at cheap stocks as well and suggests 7 cheap stocks with potential for price appreciation. They also offer a note of caution about just looking at the cheap part!

Stocks under $5 usually aren’t the best stocks. After all, almost every company prices their initial public offering at $10 per share or more. Thus, if a stock is trading under $5, that means the stock has most likely been subject to a 50%-plus sell-off, which is a sign that the company is having major trouble.

For this reason alone, stocks under $5 should be classified as high-risk stocks by investors.

But, some of them should also be classified as high-reward stocks. Again, stocks under $5 got there because investors sold them in bunches. That means investor sentiment surrounding these stocks is depressed, and expectations are low. If the company can top those low expectations and sentiment dramatically improves, these same really beaten up stocks can become huge overnight winners.

They mention both Snap and Pandora with both doubled in stock price recently. The seven that they offer as buying opportunities are these.

Blue Apron: makes meal kits
Pier 1: Struggling but possibly recovering retailer
Big 5 Sporting Goods: sells sporting goods
Groupon: coupon and savings platform whose demise is not imminent
Francesca’s: woman’s clothing retailer up for acquisition
Blink: charges electronic vehicles
Sirius XM: broadcasting

The arguments for buying these stocks range from “all of the damage has already been done” to “putting their house in order” to “just wait until the need for their services catches up” which is the case for Blink as more and more electronic vehicles are sold.

In each case, investors should be wary and should realize that these stocks are risky propositions. And, in every case, these are not stocks to buy hold and forget about unless you have an investing “death wish!”

Recognizing the Right Value Story

There are times when the stock of a company is falling like a rock and everyone is bailing out, only to discover that the investment makes a huge comeback. One case in point was Sears several years ago. Yes, Sears was the leading retailer, fell behind the times and lost pretty much everything. Even today it is in trouble. But, in the early days of its demise the stock made a huge comeback. This was because investors finally realized how much property Sears owned!

Unencumbered property is generally considered part of a company’s margin of safety. However, in the case of Sears, they were unable to change how they did business, stay ahead of the issue of online sales, and only delayed the inevitable by selling their real estate arm to General Growth in 1995.

Nevertheless, for anyone who looked past Sears as a cheap and dying stock, recognized them as a real estate investment, and then purchased shares, it was a great investment. However, that factor only lasted while it lasted, making Sears a very good investment for a very short time.

When Are Cheap Investments the Best Investments?

The moral to this story is that cheap investments are the best investments when the market is looking elsewhere, when there is overlooked value, and when market enthusiasm drives up valuations into the stratosphere while leaving value stocks behind. Such may be the case today.

The unique financial conditions of the last several years have been ideal for high tech growth stocks, the FANG group especially. But, now that conditions are changing, growth stocks are overpriced and at risk for a major correction. The better choice for many investors is to move into value stocks and other investments. But, what is a value stock?

In the article we revisited the concept of intrinsic value and how to calculate it. But, if you want to move into different investments what do you pick? The value of an investment in this regard is its forward looking income stream. Here we might consider looking at large, medium, or small cap investments. How have they done as groups and how are they doing now? As a group large caps provided more profits than medium and small caps in the last decade and as a group they are less likely to generate similar gains compared to medium and small caps today.

Large Cap Stocks

The most commonly watched indexes are the S&P 500 and the Dow Jones Industrial Average. These are both collections of large cap stocks. The S&P 500 has come from its lowest of 683 in March of 2009 to 2785 right now. That has been a spectacular rise. But, in the last three months the index has come from 2664 with a dip to 2581 in February. The Dow Jones was at 6626 in March 2009 and is 25,250 right now. In the last 3 months it went up to 26,616 and fell to 23,860. The point being that large cap stocks may have run their course and may be due for more of a correction. At this moment both the Dow and the S&P 500 are down about half a percent on the day.

From their lows in 2009 the large cap stocks have come up more than fourfold and they have showed signs of correction in the last 1 to 3 months.

Medium Cap Stocks

The S&P 400 is a medium cap index. It bottomed out at 406 in March of 2009 and stands at 1952 right now. A month ago it stood at 1839. The index is up a fraction of a percent on the day. This group is up nearly fourfold since its lows. And as a group medium caps look stronger than large caps in the short term.

Small Cap Stocks

The S&P 600 is an index of small cap stocks. It stood at 225 in March of 2009 and stands at 975 today. In the last month it has risen from 911 to its current level. Small caps have come up fourfold since their lows and like the midcaps they are doing better than large caps in the short term.

Penny Stocks

Investing in penny stocks can be tricky. First there is the question of knowing what penny stocks to watch. We have also written that it is wise to beware of penny stocks if you are not willing to do your homework, pay attention and accept the risk. The issue with penny stocks is that you basically need inside information in order to pick the winners and then you typically need impeccable market timing to gain your profits.

A penny stock typically trades at a relatively low price and has a small market capitalization, usually outside of the major market exchanges. These stocks are generally considered highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure. They often trade over the counter through the OTCBB and pink sheets.

So, why buy penny stocks? Most penny stocks deserve their low price but there are diamonds in the rough. Trendshare poses the question, should you buy penny stocks?

You must do your research to find any good stock. Plenty of stocks are undervalued, but to prove that you must understand their business. Why is the stock price so low? Is the company struggling? What are the chances it will succeed? Most of these businesses are risky gambles, and they’re obvious even after a few minutes of looking. That’s why penny stocks are bad. Your research time could pay for itself.

Because so many penny stocks are bad investments and even subject to pump and dump price manipulation most investors avoid this entire market niche. That having been said there are good penny stocks that will make a lot money if you find them. How does that work? You can do all of the research yourself or you can use the advice of market analysts.

Penny Stock Suggestions

Money Morning routinely offers penny stock suggestions. Here are their 5 top penny stocks from a recent article.

Today we’re bringing you our updated list of the top five penny stocks this week. All of the penny stocks in this week’s list delivered market-busting gains last week, with the top-performing stock rising over 170%. Money Morning updates our top five penny stocks list every week for readers. We only add stocks from the most reputable exchanges, like the NYSEMKT or Nadsaq, to our list. That’s because these exchanges require more rigorous financial standards than Over-the-Counter (OTC) markets.

It is important to note that they do not pick penny stocks from OTC markets but rather stocks that are held to higher financial reporting standards, which makes analysis more accurate. These are their most recent picks.

Lucas Energy, LEI
International Shipholding, ISHC
Ekso Bionics Holdings Inc., EKSO
Novavax Inc., NVAX
Neonode Inc., NEON

Lucas Energy is a depressed energy stock while International Shipholding is a maritime shipper and a turnaround play. Both of these stocks get better if the economy improves.

Ekso is a fast growing company that makes exoskeleton devices or wearable robots. It this stock succeeds it will be phenomenal. But remember what Warren Buffet says about picking stocks in fast growing sectors. You can predict that the sector will grow but it is hard to predict the individual winners.

Novavax is a biotech company that makes vaccines with a proprietary synthetic gene method. Like other biotech companies this one could soar to huge profits as the biotech sector grows but picking individual winners is tough.

Neonode  develops optical sensing technology that turns surfaces like tabletops into touch screen surfaces for smart devices. The same promises and same cautions apply to this stock as to other high techs.

With all the trouble picking winners why buy penny stocks? Adding a reasonable number of well-chosen penny stocks to your portfolio offers the possibility of an investing home run or two with hundred fold or even thousand fold gains.

Why Buy Penny Stocks? PPT

The key to how to find good penny stocks to buy today is knowing what you are buying and if it fits your needs.

The first thing you want to do as a penny stock investor is figure out how much money you have to work with. Basically, don’t invest anything you can’t afford to lose.
We typically recommend no more than about 2% of your portfolio in one penny stock.

There are some great buys in penny stocks and there are penny stocks where scammers pump and dump. The first step is to avoid the scammers or over-hyped stocks of the day.

Problems with Penny Stocks

In order to invest wisely you need accurate and timely information on which to make decisions. You should be trading stocks in a liquid market that lets you enter and exit positions when you want. Investopedia offers their take on penny stocks and lists four factors that should give investors concern.

• Lack of Information Available to the Public
• No Minimum Standards
• Lack of History
• Poor Liquidity

True penny stocks do not trade on major stock exchanges. They trade via pink sheet on over-the-counter markets. These stocks are not required to file info with the Securities and Exchange Commission so you access to accurate and timely information is nil. And new penny stocks have no history. The stock may have a great story but the company and its management have no performance history for you to consider. And because these stocks trade thinly you may have trouble getting in and out of the stock at the prices you want.

Past Performance as a Predictor

We looked at an article in The Street from 2011. They described the 10 Best-Performing Stocks under $5 for that year. Check out the article for all picks. We only list the ones that are still in business and trading for more today than in 2011; info is from Google Finance.

#10, Radio One, ROIAK

This stock’s top price in 2011 was $2 a share. It peaked above $5 at the start of 2014 and trades at $2.63 a share today. It does not pay a dividend.

#7 Authentidate Holding, ADAT

The stock was trading at about $1 a share in 2011 and the highest it was until just recently was $1.82 a share in late 2014. Interestingly the stock jumped from $0.50 a share to $5.38 a share in the first days of January of 2016 and has been falling ever since, now trading at $2.60 a share.

#6 USA Technologies, USAT

This one has a bit of growth. Having traded around $2 in 2011 the stock dipped to $1 a share in early 2012 and has grown to the $4.00 to $4.50 a share range this year.

So, do penny stocks work? One might say that for the vast majority, once a penny stock always a penny stock. Many penny stocks go out of business. The only semi-impressive stock in this list is #6. You can see how penny stocks get hyped when they have a good year. People buy at that point only to see the company go out or business, steadily lose money, or at best grow a little. The only stock in this list that did as well as the S&P 500 in the last five years was USAT.

Do Penny Stocks Work? PPT

A penny stock is a stock that trades at a relatively low price and market capitalization, usually outside of the major market exchanges. The term itself is a misnomer because there is no generally accepted definition of a penny stock. Some consider it to be any stock that trades for pennies or those that trade for under $5, while others consider any stock trading off of the major market exchanges as a penny stock. However, confusion can occur as there are some very large companies, based on market capitalization, that trade below $5 per share.

A penny stock with which you could have made money was the old Chrysler. At the start of the 1980’s Chrysler, a 50-year-old automaker was in trouble again. Its stock was selling in the single digits instead of at $40 where it was usually positioned. Then Lee Iacocca came from Ford and took over Chrysler. Here is what The New York Times had to say about Chrysler and other 10 super stocks of 1982.

WHO would have thought 12 months ago that Chrysler, the much maligned auto maker, or Winnebago, the once hapless manufacturer of recreational vehicles, or Pulte Homes, a builder, would not only weather one of the worst recessions ever but then soar past a stock market that was registering its biggest advance in history?

Chrysler was most certainly the surprise stock of the year, beginning just above $3 a share and breaking the $18 mark. And it was still spiraling upward in the final weeks of December. The No. 3 auto maker had cut costs to the bone to avert bankruptcy and had entered 1982 a shadow of its former self, needing sales of only 1.1 million cars and trucks to break even, versus 2.4 million a few years ago.

The stock subsequently went to the $40 range and those who knew what to look for when picking penny stocks were amply rewarded. What to look for when picking penny stocks is evidence that the stock has intrinsic value, a forward looking income stream.

Penny Stocks Today

Money Morning reports that the week’s 5 best penny stocks gained as much as 252%.

In today’s slow growth environment, the best penny stocks continue to attract investors because of their outsized gains. And each of this week’s five best penny stocks logged a double-digit gain last week.

In fact, one of the best penny stocks in 2016 is up an incredible 252% year to date.

While penny stocks can bring huge profits, they can also bring volatility. That’s why Money Morning experts recommend that penny stocks only represent a small percentage of your portfolio. And one stock should never account for more than 2% of your investing money.

The 5 penny stocks in question are Tyr Pharma (LIFE), Granay Montero (GRAM), Chesapeake Energy Corp. (CHK), Great Basin Scientific Inc. (GBSN) and Companhia Siderurgica Nacional (SID). The last one is based in Brazil, sells as an ADR on the NYSE and is involved in exports of raw materials to China. The stock jumped on better than expected March trade data out of China.

Any of these penny stocks might be a good buy going forward or in each case the expected profit bump might have already happened. Remember Chrysler when investing in penny stocks. The company was in and out of trouble over the years and finally was taken over by Fiat. You could have made nice profits with timely investments but not by holding to stock until the next problem arose.

What to Look for When Picking Penny Stocks PPT

For the beginning investor with a small amount of capital penny stocks can seem attractive. They wonder how to invest in penny stocks. Before looking at how to invest in penny stocks let’s see what we are talking about. These are stocks that typically sell for less than $5 a share ($1 by some definitions) and, thus, allow the investor to buy a block of shares for less than if buying 3M for $86.20 a share of Google for $595.47 a share. Penny stocks are often companies that are starting up and have a net worth in the millions instead of billions. Because few if any stock analysts follow penny stocks they can be sleepers with a large degree of hidden value. How to invest in stocks, in general, is to know the fundamentals of the stock. This can be difficult with penny stocks. Thus penny stocks can be traps into which the unsuspecting investor might fall.

Beware of penny stocks. If you have unique insight into the company you may know something that stock analysts do not. This can be very profitable. If you do not have any special insight into the stock you may be in for a rude awakening when the stock that sold for pennies now is out of business. We are not the only ones to advise investors to beware of penny stocks.

Price per Share versus P/E Ratio

USA Today writes about penny stocks.

Beginning investors are often attracted to penny stocks thinking the low per-share price means they’re cheap. But this thinking is misguided. Keep in mind the per-share price by itself doesn’t tell you much about a stock. It’s the per-share price compared with the company’s profit, revenue or cash flow that tells you if the stock is actually cheap or not. Some penny stocks could be the most overvalued stocks you can buy – if the company’s profits are evaporating, the company loses money or has poor prospects. Penny stocks are also prime targets for scammers. Their low per-share prices make them easy targets to be manipulated. They are also at risk of being delisted from the exchanges. Most online brokers allow you to buy penny stocks, but most charge added surcharges. Only 15 stocks in the Russell 3000 trade for less than $1 a share. Avoid those.

Share price compared to profit is the price to earnings ratio (P/E ratio). A high P/E ratio indicates that the stock is expensive and a low P/E ratio indicates that it is cheap. In our recent article about the risk of higher interest rates we note that blue chip stocks are being bid up and more risky stocks, such as penny stocks, are being bid down as investors flee to quality. Beware of penny stocks at a time when interest rates and thus the cost of doing business are going to go up and putting pressure on weak companies. Always remember that there is a reason why a stock sells for pennies and that reason may simply be that the stock shows very little promise of long term success.

Beware of Penny Stocks PPT

Who Will Run the Post Bernanke Federal Reserve?

The current front runner for the position is Janet Yellen who is the vice-chair of the US Fed board of governors. She was also a key player in the development of the quantitative easing program. Yellen moved to the front when previous front runner Larry Summers bowed out in response to expected opposition from Democratic senators. Others with include Donald Kohn who worked at the Fed for forty years and as a governor for the last eleven and vice chairman for four and Alan Blinder who is also a former Fed vice chairman. These folks are all insiders and could well be expected to continue current policies for which they have consistently voted. A dark horse prospect is Stanley Fischer should the President decide to pick someone from outside of the Fed. Born in Zambia, Fischer was a governor of the Bank of Israel and is a highly respected economist. As the anticipated end of bond purchases drives stocks down investors are concerned that a radical change in direction could greatly upset markets and the economic recovery. As such many expect the President to pick the front runner, Yellen. However, there is no reason that the President could not ask Mr. Bernanke to stay on! A decision to delay a post Bernanke Federal Reserve might surprise many but be a comfort to the markets.

Profitable Investing in the Era of the Post Bernanke Federal Reserve

Sound stock investing principles do not change no matter who runs the Fed or who is in the White House. Wise investors look at the intrinsic value of a stock and its margin of safety. A company with fundamentals that predict continued growth is a good long term pick. A company that has a good margin of safety in the form of property, inventory, and low debt will remain strong throughout an economic downturn. In the post Bernanke Federal Reserve era general economic principles will still apply and those who watch closely and do their homework will succeed.

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Preserving Capital

Those with a large amount of wealth keep their wealth by avoiding risky investments. That is not to say that a large investment fund cannot look to get in on the ground floor of the next Microsoft or Google. Rather in profitable asset management the asset manager balances his or her approach to avoid putting all eggs in one risky basket. One way to protect against risk when investing in small cap growth stocks is to invest small amounts in many of them.
As the authors of A Random Walk Down Wall Street mention, investing in around 40 small cap growth stocks improves the odds of finding a spectacular winner than will grow a thousand fold. It also diminishes the likelihood of losing all investment capital when a single stock goes belly up.

Staying Ahead of Inflation

Inflation eats away at wealth. Thus profitable asset management deals with staying ahead of inflation. The calculation of intrinsic stock value, or value of any potential investment, compares the investment with the current rate of US Treasuries, a good measure of inflation. By using the rate of the ten or thirty year bond as a guide, long term asset managers seek to gain the rate of inflation and a few percent more per year on the various assets in their portfolios.

Seeing the Future and Investing in It

The old AT&T was a great growth stock for the first part of the 20th century. America was expanding and putting telephones in virtually every home.
This company had the monopoly on long distance service and most local service. Those who saw the dynamics of this movement invested in AT&T and prospered. Coca Cola was not always a large cap stock. But those who recognized the popularity of the beverage and the soundness of the company’s management prospered for generations. Those who invested in Microsoft when it first issued stock have seen their investment multiply twenty thousand fold.
Today the stock pays a healthy dividend and is pretty much done growing. However, from the view of profitable asset management, a dollar invested in Microsoft when it went public now pays for itself nearly a thousand times over in current dividends. Think of Apple when Jobs came back. Now think of profitable asset management with investment in a few well-chosen stocks that may change the world. Whether you goal is investing for retirement or even the longer term for your kids, a balanced approach is to pick a range of investment vehicles and follow the fundamentals on each frequently.

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The Hispanic Vote and Bipartisan Support on Immigration Issues

Republican efforts to unseat President Obama came to naught in the last election. A large part of that was the large majority of Hispanics who voted Democrat. It may well be that the Republican Party has decided to realign itself on immigration issues in order to garner more Hispanic votes in coming elections. Certainly, the issue of over ten million undocumented persons within the USA is a problem that should have been dealt with much sooner. As with all such issues compromise is necessary on all fronts. If both major parties can come to agreement we may see a wholesale rewriting of immigration law. That could greatly affect the issue of investing and immigration reform as it could make some businesses cheaper to run, some more expensive, some more profitable, and some more likely to lose money. How immigration issue will affect the national budget remains to be seen but that could be central to the issue of investing and immigration reform. Picking new winners in this matter may simply be a matter of looking for companies that process data effectively.

How Fast and How Effective

The President has outlined his plan for immigration reform. It would include illegal immigrants having to register as a first step toward possible citizenship. These people would “submit biometric data” which is code for being finger printed and having your photo taken. Applicants would have to pass background checks and pay fees in order to obtain a “provisional status.” Then “provisionals” would need to wait their place in the immigration line for permanent residency followed by citizenship. Considering the large number of people likely to apply for citizenship using this or whatever process is decided upon, investing and immigration reform may point to profits for those companies that can provide services to streamline this process and make it less expensive. The fact that many business leaders are positive on this matter fits with the assumption that an immigration fix will benefit the country as a whole. Certainly making it easier for immigrants to get work permits could reduce the cost of stopping people at the border. What is a good investment in this area? Look at what economic changes might result and invest accordingly.

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A new stock selling in the penny stock category will typically have no track record. Because there is little or no information and opinion available on the stock it’s price will be prone to manipulation. A scam artist can buy shares at 4 cents a piece and manage to float publicity in the business section of a news paper or online. Then, when the price jumps up to maybe 25 cents a share, the scam artist sells and the company resumes its rightful position at 2 cents a share of simply goes out of business. Learning how to invest takes time and patience. There is nothing at all wrong with investing in paper for a period of time to see how your stock picks would have turned out. In doing so one often finds that the 3M’s and Google’s go up in price and many of the penny stocks fall off the face of the earth. How to invest in penny stocks is often not to, with one exception.

The key to successful stock investing is information. How to invest in penny stocks is to find the information that you need. The rap against penny stocks is that information is scarce and sometimes inaccurate. But, what if you know something useful about the company, its products, or its markets? For example, you are a fisherman and you discover a new lure, rod and reel, or fiberglass boat that exceeds expectations and is selling at a very attractive price. You check it out and find that Catch a Fish Company, in your state, makes this product. You drive by their factory and see that they are adding on to their production space. You go to the front office and inquire. It turns out that they are hiring too because they can’t keep up with the demand for their product. You are now a dozen steps ahead of the analysts in New York, Chicago, and elsewhere. You ask about buying their stock and receive a handful of financial reports which are audited by a major accounting firm and show a large bank balance and no debt. You call a stock broker and check out how to buy the stock over the counter before it goes up in price and gets listed on the NYSE. Here in our example you have done your fundamental analysis all in one step. This is an example of how to invest in penny stocks; go out and find the information that you cannot find online or from a broker.

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