The system works! Every degenerate gambler in Las Vegas believes that mantra, and I am starting to believe it myself. The model I have developed for my new trading venture, Excelsior Capital Partners, has already produced two very lucrative trades. I mentioned nine stocks that my model had identified as being massively overvalued (see below for the full list) in my Real Money column last Thursday. Two hours after that column posted, Illumna (ILMN) surprised the Street with a truly nasty profit warning, and last night's admission of a shocking lack of subscriber growth in the second quarter has tanked Netflix (NFLX) shares today.
So far so good, and I will continue to build short positions, usually via buying put options, in the other names on my hit list. While my valuation methodology will remain proprietary to Excelsior, I am not giving anything away by noting that it is based on publicly available financial data and estimates. So, why aren't other fund managers doing these trades? Well, some are, of course, and the bidding up of implied volatility in options contracts before earnings reports (this is especially apparent in Netflix's option chain) turned my trades in ILMN and NFLX from great to merely very good.
The profits are there for the taking, though, and that leads to the key issue facing the U.S stock market and its valuation. Sometimes it seems as if nobody is actually trying to value it. It is just go-go-go and let's all dance to the tune of our Pied Piper, Federal Reserve Chair Jerome Powell. That works until it doesn't work, and when it does work, it is most effective via broad market ETFs like (SPY) .
As CNBC's Bob Pisani likes to note, though, it's a market of stocks, not a stock market. Some semblance of sanity seems to be returning to the market with this week's pullback, but we are still very near all-time highs for the three major U.S. indices. In its rush to push stock prices to the stratosphere, the market has priced in growth rates that just are not attainable. That's where the idiosyncratic factors driving individual stock valuations come into play, and that's what has pushed Excelsior out of the gates with big gains.
So, the market that is go-go-go has really been laser-focused on growth-growth-growth without the proper due diligence being applied to the companies that need to produce that growth. Illumina's revised revenue guidance notes sales in the second quarter of $835 million versus $830 million in the second quarter of 2018. That's a 0.6% growth rate. But ILMN, was - and still is - valued by the markets as a "growth stock" in the "growth industry" of genetic sequencing.
The market also missed a deterioration in Netflix's fundamentals. The 2.7 million net subscribers Netflix added in the second quarter compute to a 1.8% sequential growth rate. But NFLX is a growth stock, or so the bulls would tell you.
While Excelsior is in its infancy, my Wall Street career spans more than 27 years. I have learned a thing or two. The genesis of my system is my fervent belief that when stock fundamentals and stock valuations diverge, profit opportunities are created. It's working so far.
Intuitive Surgical (ISRG)
Hon Hai (HNHPF)