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‘Go For Growth’ Still A Sound Strategy In Today’s Market

Stocks perceived as mitigating the effects of market volatility were popular among investors in the first quarter. Big swings in equity markets drove a flight to quality that benefitted dividend-paying sectors such as Utilities and Telecommunication Services (which were the two best-performing sectors in both ACWI and the Russell 3000). We largely have avoided those sectors due to their elevated valuations and the fact that we don’t believe they offer the growth possibilities that are necessary to generate long-term returns. While some high-profile growth stocks trade at triple-digit P/E valuations today, the reality is that the vast majority of growth stocks do not, and we do not believe it is worthwhile to examine what is happening with the growth story. The case for growth stocks in a low-growth world is relatively straightforward. All else being equal, companies that are capable of delivering above-average growth in a low-growth world should be rewarded by investors over time. However, in investing, all else is rarely equal. A high-growth stock at an unsustainably high valuation can be just as risky as – or even more risky than – a company that is in secular decline. 2015 was the best year since 2009 for major U.S. growth indices (e.g., Russell 1000 Growth, S&P 500 Growth) versus their value counterparts (e.g., Russell 1000 Value, S&P 500 Value), so it makes sense to take a deeper dive. The median growth stock trades at a similar valuation (on both an absolute and relative basis versus non-growth stocks) to where it started 2015. For example, the median P/E of Russell 1000 Growth stocks that have no weight assigned to the Russell 1000 Value traded at a next 12-month P/E of 19.4 at the start of 2015. This group of stocks entered 2016 with a very similar next 12-month P/E of 19.5, and ended the first quarter at 19.7. Absolute valuations for this group as a whole are not cheap, and therefore, risks associated with coming up short of investor expectations can be high. However, the premium for these high-growth businesses versus the rest of the Russell 1000 is well within historical norms (see chart below). Against this backdrop, we continue to seek opportunities to own well-positioned, growth-oriented businesses with valuations that offer attractive compensation for the risks taken. The number of such opportunities might be fewer than earlier in the current market cycle, but we believe a selective and active approach to investing can maximize the likelihood of finding such companies today. Click to enlarge Investing in companies that can grow their earnings at rates above the trend in broad economic growth is particularly important in today’s slow-growth economy. As an illustration, we’ve taken returns in the U.S. equity market on a rolling 10-year basis and broken them down into how much came from earnings growth and how much came from changes in the P/E multiple (i.e., multiple expansion or contraction). Beginning in 1970, it has been earnings growth that has been more consistent and stable most of the time (see chart below). Historically, earnings growth has been a more reliable contributor to the returns we get as investors than multiple expansion. Click to enlarge While there certainly are periods in which multiple expansion drove or provided a boost to returns, changes in multiples have been quite volatile. In the 1980s and 1990s – when multiple growth helped returns – the market was coming off some attractive starting valuations and had a backdrop that was favorable for rising valuations. As a result, there was solid multiple expansion. But before that – and, more importantly, recently – not only could investors not rely on multiple expansion, they also had to deal with multiple contraction. This is one illustration of why we believe it is particularly important right now to focus on companies that are capable of growing their earnings on an individual basis, which, in our view, puts investors in a much better position to generate positive returns. Past performance does not guarantee future results.

4 Energy Mutual Funds To Buy As Oil Prices Move North

For a considerable period of time, the energy sector was plagued by an abundant supply of oil. While major oil producing nations pumped oil, demand moved south on global economic sluggishness. However, disruptions in oil suppliers, including Nigeria and Canada, were more than welcome by the beleaguered energy sector. U.S. shale output is also likely to decline in June says the U.S. Energy Information Administration (EIA). These factors collectively helped U.S. crude price to reach a seven-month high on Tuesday and the Goldman Sachs Group, Inc. (NYSE: GS ) to have a bullish outlook. The banking behemoth went a step further saying that it expects crude demand to improve this year, which will further reduce the demand-supply disparity. Given these positive trends, investing in energy mutual funds won’t be a bad proposition. Nigerian Saboteurs, Canadian Wildfires Supply outages in Nigeria along with wildfires in Canada continue to boost oil prices. In Nigeria, attacks by a militant group called Delta Avengers on oil installations led to shut down in production. Nigeria reduced its crude production to 1.69 million barrels per day (bpd), hitting its lowest level in 22 years. The group has recently bombed an offshore platform owned by Chevron Corporation (NYSE: CVX ). Among the other attacks, this group targeted a series of refineries and an export terminal. The Alberta region in Canada has, on the other hand, been under fire for two weeks now that is threatening major oil sands production facilities. According to the Conference Board of Canada, these facilities are estimated to produce 1.2 million barrels a day, which almost comprise $1 billion in economic activity. Investors are also keeping an eye on other oil producing nations such as Venezuela and China. Venezuela is in the grip of a serious economic crisis. The country is currently operating under a “constitutional state of emergency,” thanks to its high inflation rate and shortages in food and power. Meanwhile, China witnessed crude output of 4.04 million bpd in April this year, reflecting a 5.6% decline from the year-ago level. Goldman Projects Deficit in Oil Market Supply shortages mostly in Nigeria and Canada prompted Goldman Sachs to say that the oil market is facing a deficit in crude production. Goldman reversed its bearish bet and raised its oil price forecast for this year to $51 a barrel. A few months ago, Goldman projected that oil prices would remain around $20 per barrel following crude oversupply. Goldman also said that “the oil market has gone from nearing storage saturation to being in deficit much earlier than” it anticipated. U.S. Shale Oil Output Declines According to the monthly report from the EIA, output from seven major U.S. shale plays is likely to fall by 113,000 bpd to 4.85 million bpd in June. The profitability of shale drillers has been seriously affected, leading to such a projection. At the Eagle Ford shale play in South Texas, oil output is expected to witness the highest drop, down 58,000 barrels in June. The Bakken Shale play, which stretches from Canada into North Dakota and Montana, will experience the second largest decline in output, a projected fall of 28,000 bpd, the report mentioned. Top 4 Energy Mutual Funds to Invest In Oversupply of oil has always been a major concern for energy companies. But, as mentioned above, supply side disruptions have helped oil prices gain momentum. Demand, on the other hand, is expected to gain traction. Goldman projects 2016 worldwide crude demand to improve by 1.4 million bpd, which is higher than its prior expectation. This will further bridge the gap between supply and demand. Banking on these bullish trends, it will be judicious to invest in mutual funds that have considerable exposure to the energy sector. We have selected four such energy mutual funds that have given impressive year-to-date returns, boast a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy), offer a minimum initial investment within $2,500 and carry a low expense ratio. Funds have been selected over stocks, since funds reduce transaction costs for investors. Funds also diversify the portfolio without the numerous commission charges that stocks need to bear. Fidelity Advisor Energy Fund A (MUTF: FANAX ) invests a major portion of its assets in securities of companies engaged in the energy field, including the conventional areas of oil, gas, electricity and coal. FANAX’s year-to-date return is 12.5%. Annual expense ratio of 1.11% is lower than the category average of 1.47%. FANAX has a Zacks Mutual Fund Rank #2. Guinness Atkinson Global Energy Fund (MUTF: GAGEX ) invests the majority of its assets in equity securities of both U.S. and non-U.S. companies engaged in the production, exploration or discovery, or distribution of energy. GAGEX’s year-to-date return is 12.1%. Annual expense ratio of 1.41% is lower than the category average of 1.47%. GAGEX has a Zacks Mutual Fund Rank #2. Vanguard Energy Fund (MUTF: VGENX ) invests a large portion of its assets in the common stocks of companies involved in activities in the energy industry, such as the exploration, production and transmission of energy or energy fuels. VGENX’s year-to-date return is 16.4%. Annual expense ratio of 0.37% is lower than the category average of 1.47%. VGENX has a Zacks Mutual Fund Rank #1. Fidelity Select Energy Service Portfolio (MUTF: FSESX ) invests a major portion of its assets in securities of companies engaged in the energy service field, including those that provide services and equipment to the conventional areas of oil, gas, electricity, and coal. FSESX’s year-to-date return is 5.1%. Annual expense ratio of 0.81% is lower than the category average of 1.47%. FSESX has a Zacks Mutual Fund Rank #2. Original Post

Stock Market Values – How To Value A Company With No Earnings

Is it just a case of irrational exuberance? Not necessarily. Traditional discounted cash flow analysis is a useful tool when it comes to evaluating financial assets, but it has its limitations. One aspect of investing that DCF analysis ignores is management’s flexibility. They can delay bringing a product to market, or expand its production to meet an unexpected surge in demand, or shift how their facilities are used – perhaps to produce a different kind of product. This kind of flexibility has real value. To capture this value, we use option-pricing methods to supplement traditional valuation. An option is an asset that can go up, but is limited to the downside. If management possesses a patent on a new drug, that patent has value even though it’s not producing cash right now. The upside may be huge while the downside is limited to the cost of bringing the medicine to the marketplace. Click to enlarge Call option pricing. Source: Wikipedia This is also why many tech companies seem to persistently carry such high valuations. The market is putting a high value of its potential growth, and the flexibility management has to pursue different approaches to its business. Putting a value on this kind of asset – management flexibility – is difficult, but it can be done. It depends on the cost of exercising the flexibility, the potential upside a change could realize, the amount of time management has to make the decision, and how volatile conditions are. The more volatile things are, the more these options have value. These values can all be quantified in a pricing model. Click to enlarge Black-Scholes Option Pricing Formula. Source: Wikipedia In practice, this involves a lot of assumptions about stock prices and strike prices and market volatility run through an analytical model with decision points and normal distributions. Additionally, the real world will insert complexities that our models can’t accommodate. Nevertheless, options methodology is essential for understanding why some money-losing companies still have high market values and why some profitable companies seem so cheap. Today, it seems the market is putting a lot of value on the options that Internet-media companies like Amazon (NASDAQ: AMZN ) and Netflix (NASDAQ: NFLX ) possess. It’s not necessarily irrational just because you don’t understand it. Sometimes, what is unseen is more important than what is seen. It’s all in the options. Disclosure: I am/we are long THE MARKET. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.