As part of our OSV Online offering, I send out bite sized email tutorials to insiders to get them accustomed with the tool and show how they can maximize the tool in their own workflow.
With our new scoring and grading system, dubbed the “Action Score”, you’re now able to get a big picture of the stock within minutes.
In email “Tip #13″ of our Insider training email series, I write about “Action Score Volatility – 3 IMPORTANT Points to Understand”.
Our scoring system is different in that:
- we tell you exactly what makes up each of our Quality, Value, Growth and Action scores
- it’s fundamentals driven
- it’s value focused
There will come a time when I research how momentum and technicals boost performance, but as of today, it is the deepest value driven scoring system on the market.
We use numbers and methods that Wall Street, traders and speculators will never adopt. This prevents crowding and ensures that our group is one of a kind. No crowding.
I mean, Piotroski F Scores on Wall Street?!?
Never.
But I want to visit the concept of volatility and how you should think about it.
The perfect example for today is CALM (Cal-Maine Foods).
CALM and Volatility
Starting 2016, CALM started off with A’s throughout. Great numbers, great company, great growth.
But something happened.
The latest quarterly filing pushed CALM from an A rated stock to a C rated stock.
The question I get often is “why the big sudden change?”.
I’m a firm believer of the quote by John Maynard Keynes.
“When the facts change, I change my mind.”
But at the same time, it’s just as important to understand what the changes are and why.
Quick summary of the Tip #13 email
Criteria that makes up the Q,V,G and Action Score are:
- FCF/Sales
- CROIC
- Piotroski score
- P/FCF
- EV/EBIT
- P/B
- TTM sales percentage change
- 5 year sales CAGR
- Gross Profit to Asset Ratio (GPA)
The number one reason for changes in the Action Score is the Piotroski F score.
It is used to first filter the entire universe for each of the Q, V and G score calculation.
I leverage the Piotroski F Score model extensively because it’s simple and it works. If you apply the F score to stocks as an initial filter, you can eliminate junk stocks and work on the gems.
Think of it like sifting for gold. You pour mud and dirt into a pan, and then as you shake all the junk out, you’re left with the better pieces in the pan.
How this applies to CALM
CALM was rated an A for most of the year, but is now a C.
Why the huge difference?
In CALM’s latest report, they are coming off one of their best years ever. They are the best company that weathered the bird flu that hurt a lot of their competitors.
All of last year, their demand was at a peak, and egg prices were up because of the demand and limited supply.
Now with the hen population coming back up and competitors “laying eggs” like mad, egg prices have dropped.
More supply, than demand.
In other words, CALM operates in a cyclical commodity based business.
At the moment, you see trends like:
- TTM sales % change is negative
- Gross Profit to Assets has dropped
- P/FCF is 18.9 which is outside of the optimal range of < 10
This also means that the Action Score will show cyclical patterns. Up when growth is strong and the company is making money.
Down when demand is low or there is too much supply.
The latest quarterly reports show how CALM is now operating back towards the bottom of the cycle, the Piotroski F score has dropped from a 9 to a 6.
Dropping 3 points is a big factor and will allow other stocks to jump ahead. Remember that I place a lot of importance on the Pio F score.
The tradeoff with mechanical calculations
As a disclosure, I hold CALM and this is no way a defense of my position.
These changes in scores reflect that algorithms (OSV and others) are still backward looking and cannot decipher the complex world we live in.
That’s why for my testing, I always use a 20 stock portfolio and hold for 1 year.
Best results come from eliminating the desire to go in and start meddling.
I’m proud to report that one OSV insider has invested millions of his and his clients money into our system and is having a great year.
Hearing his numbers was enough to make me do a jig around the room because if he wins, OSV wins.
But most impressive is his discipline, which is paying off handsomely for him and his clients.
That’s why you buy and hold for 1 year and ignore the in-between volatility.
There’s a lot of emotion that moves the markets and a stock that started out as an A at the beginning of the year, could easily become a C and then move back to an A.
One example is Nordstrom (which I also hold). It was an A, but the stock price dropped 30+%, and rallied over the next couple of months and is now slightly higher than my buying point.
What happened?
Nothing much. Just emotional traders and short term bad headlines.
My mistake with Nordstrom was that I sold half the position because I got swept up in the fear mongering instead of believing what my eyes told me when I visited stores.
As Walter Schloss once wrote in his 16 point checklist,
“Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.”
Nordstrom (JWN) Action Score Stock in 2016
Same thing with Hawaiian Airlines.
Hawaiian Airlines 2016 performance
This time, I didn’t fall for the same psychological behavior.
Instead of looking at news and thinking I was going to dig up information, I went back to Walter Schloss’ checklist and just ignore the noise.
CALM Today
CALM is in a similar boat when you look at it superficially.
For a mechanical position, it doesn’t look good right now for sure. But when you dig a few layers, the long-term thesis is simple and compelling.
- Egg prices will stabilize
- Current numbers already look to be improving from the bottom
- People will continue to eat eggs until they die
- Restaurants are using higher quality eggs as consumers get smarter and demand better products
- Growth in specialty eggs is increasing which CALM is heavily investing in
- Short ratio is higher, only because traders use it as a hedge for their futures position. Not because there is something wrong fundamentally.
CALM is now rated a C and you can see the details for each metric from the OSV Ratings page directly.
CALM valuation video
Lastly, because of the complexities involved with trying to value a cyclical company, I shot this short video on the adjustments I make to come up with rough valuations in a short period before I dive into details.
The fair values based on DCF, Graham and EBIT multiples are not included in the Action score.
That’s why you’ll see stocks where the Action score may be rated an A, but the valuation looks way off.
This video explains how and why.
Additional Articles I Recommend
- Lessons on What To Analyze and Think About with Retail… [hurricane] The crowd of companies in this section [Manufacturing, Service…
- My Top 10 Stock Valuation Ratios and How to Use Them [jaejun] (edit: this article has been updated with additional commentary,…
- Why Apple Is the Best Retail Stock According to this 15… (This is a guest post. The author’s views are entirely…
- The Profoundly Simple Wisdom of Walter Schloss on Producing… [jaejun] What You’ll Learn Walter Schloss’ performance record vs Buffett…
- How to Value Stocks Like a Pro Using the Absolute PE Model. Learn how to value stocks using the absolute PE valuation…
This post was first published at old school value.
You can read the original blog post here Our Action Score and Cal-Maine Foods (CALM).
[via The Value Investing Blog of Old School Value] (http://ift.tt/1j3pR52)
October 6, 2016 at 11:21PM
Biz News, Trends & Advice 