I have been playing a lot gin rummy against my phone of late in an attempt to learn the game. My soon-to-be son-in-law turned me onto gin rummy, and I am just a tad addicted at this point. The probabilities and possibilities of the game intrigue me, and if I can get a few more hours a day to practice I hope to get develop a decent game before too long before too long.
I have noticed more than a few comparisons to the stock market and investing, but the most obvious occurs when you have dealt a hand with some intriguing potential high-card melds. If you can complete the meld quickly, you can knock and potentially catch your opponent with a stack of cards. But if the game goes on and you’re still searching for the card or two you need, you’re in danger of taking a big hit with your fistful of high-value cards.
Thus, I find I win more when I ditch the big cards and focus on melds of lower- and middle-value cards — sure, I could lose to a good hand, but I won’t give up many points either. In the end, playing defense keeps me in the game longer and gives me plenty of opportunities to win.
The same goes with investing. If I hold a portfolio full of big, expensive cards, I’m counting on everything going my way. The company has to excel and beat estimates, and the market has to go higher. If things don’t go our way, we can suffer a huge loss that leads to a permanent impairment of capital.
But if I stick to stocks that have solid financials and trade for less than asset value, I increase my odds of staying in the game until I can win. Even if things go wrong in the short-term and the market goes lower, if my company can survive until good times return, the odds of a permanent loss of capital are decreased substantially.
I use various measures — from simple earnings valuations to Altman Z-Scores — to find stocks that aren’t just cheap, but have the financial staying power to recover from a short-term disappointment or market collapse.
I also use the same measures to find duds.
Stocks to Avoid: Restaurant Brands International Inc (QSR)
Restaurant Brands International Inc (NYSE:QSR) is the resulting company from the $12.5 billion merger between Burger King and Tim Hortons.
I rarely get involved in qualitative judgment, but right off the bat I will note that even though I love junky fast food (to my wife’s dismay), I haven’t been in a Burger King in years. The food just isn’t that good.
I certainly don’t see anything in this company that’s worth 85 times trailing earnings and 35 times analysts’ highly accurate (ha!) estimates. If anything goes wrong for QSR, I can see it trading at half its current price, and with no long-term prospects that would drive a long-term price recovery.
If everything goes perfectly, you can make money in QSR, but any negative news or a weak market could lead to a substantial loss.
Stocks to Avoid: Simon Property Group Inc (SPG)
I have been negative on Simon Property Group Inc (NYSE:SPG) for a long time, and I remain bearish today.
SPG stock has gone up 20% in the past year, so clearly I’ve been wrong. The public and institutional love affair with the giant REITs has continued taking the price from “gee, that looks overvalued” to “are you kidding me?!”
Of course, the market might be starting to see what I’m seeing — SPG is off some 7% from its 2015 peak.
One of the more successful private real estate investors I know once told that he would not pay more than 10 times cash earnings or much more than appraised value of a property, and that was at the extreme upper end. Simon is trading at roughly 40 times current earnings and 20 times expected earnings.
You can tell me that SPG stock is popular and its heavy presence in real estate funds creates demand, but you cannot tell me that the stock is cheap enough to justify owning shares at this level.
Stocks to Avoid: Hilton Worldwide Holdings Inc (HLT)
The same goes for Hilton Worldwide Holdings Inc (NYSE:HLT). I love hotel stocks and still have several from 2009 and 2010 in my portfolio, and Hilton is a wonderful company. The hotel business is getting better and better by the day and should continue to perform well financially.
Problem: This all appears to be priced into HLT stock right now.
Hilton currently trades at 51 times trailing earnings and 33 times Wall Street’s hopes and dreams for 2015. It’s not just highly valued on earnings, either. HLT trades at more than 5 times book and has an EV/EBITDA ratio of more than 20.
Hilton is just too expensive right now.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.
