As we move into earnings season, it is probably going to be a good idea to keep the earnings torpedo list we talked about yesterday close at hand. According to FactSet, earnings are expected to decline by a little over 9% when all the first quarter reports are filed. According to chatter on the internet, this earnings decline is a good thing.
The common theme is that the decline is priced in and expectations are so low we will get lots of positive surprises. I fail to see how a market that has risen almost 6% in the past three months and is currently just 2% below the highs is pricing in bad news but that's the theory of the day. I think this may be a great time to be super cautious.
Lest you think that the University of Michigan Tozzi Financial Center is only churning out a collection of wild-eyed short sellers, there is another list the students produce each month that you might want to have close at hand as well. If we do see some earnings-related weakness this month, it may be a great time to accumulate some of the stocks on the Value 40 list produced by the Wolverines each month.
The list is produced using principles proven by academic research to produce excess returns, including things like Value, Momentum, Quality, and Predictability. It is pretty much the inverse of the torpedoes list; the Value 40 has done very well, outperforming the market in 10 of the last 13 years.
The April list is out and it reinforces one of my major investing theories: 20% of the portfolio is in community banks. I have a much greater percentage of my portfolio in these trade-of-the-decade stocks, but most people I talk with have something very close to zero exposure to small banks. Unless you are severely allergic to capital gains, this is a mistake.
Small banks face a "grow or sell" ultimatum right now, and either outcome will lead to positive results for shareholders. Best of all, the only path to growth in a weak economy is to buy other banks, so for every little bank that chooses to sell, there are several potential buyers right now. The average takeover premium is now close to 1.4x book, and there are hundreds of these little gems trading below book value.
B. Riley Financial (RILY) is also on the list. The California-based firm provides investment banking, corporate finance, research, wealth management, sales and trading services to institutions and wealthy individuals. It has a decided small-cap and value bent to its approach. It also has a division that does liquidation and auctions, helping businesses dispose of underperforming assets including things like inventory, machinery, property and intellectual properties.
Finally, it has a valuation and appraisal business that handles appraisals for financial institutions, private equity forms and other capital providers. It is a great collection of businesses, and the stock is cheap according to the metrics used by the students at the Tozzi Center.
Airline stocks are well represented on the current list. Five airlines, Alaska Air (ALSK), Delta (DAL), Hawaiian Holdings (HA) JetBlue (JBLU) and Southwest Airlines (LUV), make the AprilValue 40 list. Fuel prices are pretty low, and airlines are finding ways to squeeze every dime out of every passenger and have scheduled routes so that every flight is packed.
Even the legacy airlines are charging to select a seat that is not in the every back of the plane now, and I haven't been on a flight with an empty seat in the past year. In spite of increased profitability, the stocks are still cheap and the Michigan list says they are undervalued and could go higher this year.
I find the fact that the Tozzi Financial Center list outperforms on both the long and the short side of the market very impressive. They are using concepts proven by academic research and successfully applying them in the real world. Investors and traders alike should make it a habit to visit the school's website each month to view the updated lists. They have a long track record of providing solid long and short ideas, and could be a valuable addition to your research process.
There is a lot of solid financial research being done in universities all over the United States. We night find that surfing the Business School site of leading universities like the University of Michigan improves our long-term results far more than the just viewing the mainstream media finance sites, where much of the news is really just noise.