With the addition of so many new readers, and serve as review for my regular readers, I thought I do a Q and A about “Coming out of the Blue” investment strategy which I regularly refer to in my ModelPrice Guy blog.
What does “Coming out of the Blue,” mean?
“Coming out of the Blue” is the name we (Acker Finley research employees) give our most profitable stock strategy for position traders and long-term investors. This occurs when a stock is trading below our last line or EBV-3 and transits up through this line. (See graph below)
What is the big deal about your EBV-3 line?
EBV-3 is the last EBV line in our theory of model price that marks the boundary or connection between the balance sheet of the publicly traded company and the market. For example companies trading below EBV-3 usually have impaired assets on the balance sheet, which probably will be written off by management at a future date. Also market participants with investments in companies below EBV-3 will notice higher variability in the stock price compared to companies trading above EBV-3, as the stock price leaves the structure or boundaries of our computed higher EBV lines.
Just because our EBV lines, and EBV-3 in particular, look simplistic doesn’t mean that they should be taken lightly. The combination of stock price movement overlaid or interacting with our calculated EBV lines gives followers of this work material feedback on what “the market” is saying about the balance sheet of the company. Unlike other financial work and analysis, we plot two independent variables, the stock price and selected data from the company’s balance sheet, interacting together giving investors important market signals.
Every EBV line is illustrated for a reason, which goes back to the theory of our model price work. We color the very important ones (Blue, Green, Red, Gold etc.) to highlight significant break points in what “the market” is saying about this specific company. We color our last line EBV-3 as blue and as companies transit up through EBV-3, we call this “Coming out of the Blue” or transit down through EBV-3, “Going into the Blue”.
Why is this strategy so profitable?
Simply put, “Coming out of the Blue” or a positive transit of EBV-3 reestablishes the market connection to a trading entity through a successful financial and/or operating restructuring by old or new management. Rising above EBV-3 signifies “the market’s” willingness to initially accept the balance sheet – remember EBV-3 is still a discount to accounting book value or our own definition of book value at EBV or green line – with its stated book values. Or said another way the company’s production process is starting to accrue value to stakeholders with a positive transit of EBV-3. The key word here is “starting”. We just don’t know how far, and obviously cannot predict the timing, in terms of price and EBV lines the company will scale after the positive transit of EBV-3. Through my experience the majority of companies making a positive transit of EBV-3 will at least achieve a valuation level of EBV+2, with a few achieving EBV+5 in terms of valuation representing a 400% return to investors.
Three (3) reasons why I highlight “Coming out of the Blue” companies in my blog?
1. It is by far our most profitable investment strategy considering the possible potential of a company to go price wise from EBV-3 to EBV+5 and possibly beyond.
2. A lot of the risk – survivability, solvency, and balance sheet accuracy (in terms of stated asset values) – has been leached out the stock price before purchase. Yes, other things could go horribly wrong and you should never put 100% of your portfolio into any one security. However from a risk/reward perspective company financial risk is minimized but never completely eliminated just as long as the company stays above EBV-3. (Assuming the company’s financials are not fraudulent.)
3. Often times, many and sometimes all companies in an industry will trade below EBV-3 at the same time. Currently many of the insurance companies are trading below EBV-3, both in the US and Canada. We all know of the issues facing the life insurance industry, in terms of record low interest rates and lack of investment returns for funding contingent and potential future liabilities. If and when these companies start to transition above EBV-3, this may indicate higher interest rates or higher investment returns are forth coming in the future. In other words secular change maybe in the offing either in the way the market views these particular companies or change in the external environment in which these companies operate.
I believe it takes a special investor to troll for bargains in the stock market. It can be hard psychologically to invest in stocks that the business press heap scorn upon or better yet investors often ignore. Investors using “Coming out of the Blue” investment strategy as an investment filter will hopefully improve their odds of success as companies are transitioning from basket cases to legitimate companies with bright futures. I will always be on the lookout for these companies, transiting up through EBV-3. To me these situations are like buried treasure, the risk/reward is positively skewed in favor of the investor on the look out for these situations.