The Daily Dose: 2014 Is Here!

 | Dec 09, 2013 | 10:00 AM EST  | Comments
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For all intents and purposes 2013 is done. All that's left to see is if Bernanke will fight the froth in certain asset classes and mess up initial 2014 portfolio positioning by way of a December 18 comment bomb.

Unfortunately, eyes will have to be glued to the Fed chairman's press conference because said comment bomb is not going to be placed in the FOMC statement. A mere word that suggests an early 2014 taper will dent stock price. If it doesn't do so, then that would be a positive sign (Fed views economy as entering a sustainable period of mild growth acceleration, as recent data points would imply).

While this drama is unfolding, I have already begun to detect the usual banter on the Street, ranging from buying the Dow Dogs now, to chewing on low price-to-earnings ratio multiple stocks and to venturing into names where an activist is sure to land following the 2013 proxy filing. Woh, woh, woh, hold your horses, cowboy and cowgirl. You had best be carefully thinking through each investment philosophy being pitched on the phone or via email because 2014 will have a multitude of different factors in play that weren't in the mix in 2013. Don't get bamboozled!

Mistake #1: Falling in Love with Low P/E Multiple Stocks

Wowzers, are you picking up on the rising calls among strategists to begin massively rotating into low P/E stocks? It's disturbing in the context that it lacks discipline! I suppose it's somewhat typical to year-end, as investors seek to lock in hearty gains and seek out new opportunities for the 12-months forward, I caution, however, that buyer beware; you should not be aggressively adding low P/E multiple stocks, which were likely 2013 sector laggards, for the sake of doing so.

First, 2013 stock price gains have largely been fueled by multiple expansions, driven by expectations on Fed policy. That alone suggests 2014, with its all but inevitable reduction in monthly bond buys, will bring a slower pace of multiple expansion (or contraction), placing a greater emphasis on a company's earnings power to support the stock price. Remember, a low P/E multiple stock has that low ratio for a reason -- usually due to an inferior product or service that is causing management to ramp price competitiveness or poor positions in international end markets.

How to do you wade into the low P/E multiple waters entering 2014? Here is a simple tip: be sure that a target company has announced a new share repurchase program in the past three months. It should be one that was initiated as a result of new people at key positions in the company planning to orchestrate fundamental transformation.

Examples of fundamental transformations: (1) a reset of an entire product or service suite with a solid marketing budget behind it; (2) a rationalization of the business. By initiating the new share repurchase program today, the company in effect views its stock as cheap in advance of stronger future earnings power by the aforementioned initiatives.

Mistake #2: Buying High P/E Multiple Stocks Out of Sheer Laziness

 Sureeeeee champ, buy that amazing story of 2013 trading at 25x forward earnings. Damnit, another robust year is on tap and hey, there is no time to research given the stress of the holiday season. Listen, you must figure out if that leading stock of 2013, for example a Starbucks (SBUX), which is valued as a leader, is still a worthwhile buy. Or is it a name destined for a pullback come earnings season due to a "disappointing" 25% sales growth quarter.

When researching, are you left with the sense that a 25x forward P/E multiple company received that high ranking due mainly to liquidity sloshing around the financial system? Or is it because of fundamentals that stand to strengthen to the surprise of the market in 2014 with less liquidity sloshing around the financial system. Rich multiple stocks must have underlying companies on track to release new, relevant products that could remove themselves from strong, global price competitive forces and plow those winnings back into shareholder friendly actions.

Mistake #3: Misguided Activist Investor Stalking

 An activist investor is not going to arrive on the doorstep of a dog of a company simply because its stock was hammered in 2013. On the contrary, an activist will appear at those companies boasting a good business with entrenched management teams that are unduly enriching themselves, while not setting up the company to win in the next 12-month following a lackluster 2013.

Examples of where activists could land in 2014: Abercrombie & Fitch and Staples. Remember, to properly select a potential name where an activist could swoop in to unlock value, you have to think like the activist investor and drill deep into the fundamentals (and yes, that means reading a proxy filing to see how executives are being compensated).

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