How To Protect Your Portfolio As Well As Your Colleague's

Ultimately, protecting your portfolio is about buying safe stocks, selling dangerous stocks. And safe is defined as attractive risk-reward. When you live in a world where there is a limited amount of ability to predict the future, the best you can do is manage risk-reward. If you don't have a crystal ball, you work on what is the best risk-reward. And so what is risk? How do you minimize that? How do you really, at the end of the day, when there's blood in the streets, what matters most? And that's where Cash is King comes in, comes into play. Look, at the end of the day, whatever momentum strategy you're using or whatever, it, it can work until it doesn't, which means you never know when it's going to stop. It's a game of musical chairs. The one thing you know that you can put your head on your pillow at night and feel good about is cash, right? As long as the As long as you're in an investment that has real cash value that's equal to above its price. Well, how do you measure that? How do you get it? That's the hard part. Yes, true. But listen, if it were easy, everyone would be doing it. It's not always easy. But the takeaway is, at the end of the day, if you got cash in your hand, that's the only currency that matters in a bear market. And ultimately, over the long term, companies can't hide the fact that they don't have cash forever, right? The other part of the strategy is understand what dangerous means. What are dangerous stocks? What are the opposite of attractive stocks? Strong downside risk, weak upside potential, right? What exactly is that? What does that mean? Where's the risk? It's the risk the profits aren't what they say they are. It's the risk the profits are lower than what the market believes. It's the risk that the valuation is disconnected. Again, this is diligence, the kind of diligence that those who've listened to many of our webinars know that we specialize and focus on doing, right? And I'm putting my money where my mouth is here. How do you find safe stocks, right? Here's actionable advice, right? Go to our most attractive stocks. We'll go through some of this later because I'm going to get through sort of, you know, what's the methodology around this. But I want you to know, those people who watch this understand Exactly how to get, you know, I'm giving you the, I'm giving you the strategy, I'm telling you exactly what it means, and I'm helping you execute. So safe stocks, you go to our most attractive stocks, it's 40 large-cap, 40 small-cap stocks every month updated on our site. And in our PowerPoint presentation, in the presentation you have access to, these are all links that you can use to get direct to these places. Long ideas, every week we've got long ideas on our blog. Right? Some recent ones, 10 Stocks to Get You Through a Bear Market, huge hit on Forbes and Seeking Alpha. And we're going to give you kind of the methodology behind it, let you understand why it's safe. The market values high ROIC companies. It's a great article we wrote talking about how companies that earn lots of cash based on relative to the amount of cash in the business are great companies, great stocks. That's what you need to be in. That's what matters. And by the way, In 2008, the stocks that outperformed, the only stocks that outperformed that are still around today, had amongst the highest return on invested capital of all companies in the market. So at the end of the day, and really return on invested capital is the best real measure of cash, right? When I say cash, yes, the cash in your hand is of course what matters, but what also matters is how much cash the the company generates relative to how much capital has gone into the business. If it's a business that's taken millions and millions of capital to get going and it only generates $100, eh, not so good. If it's taken millions and millions to generate— to get the business going and it's generating millions and millions of bucks, that's a good return on capital. So, you know, it's important to understand these distinctions. And then we'll give you specific ideas, like a long idea on Allegiant. And then there's the Education Center to get details about how we do this. The dangerous stocks, there's the Most Dangerous Stocks newsletter every month, 40 of the most dangerous stocks, large cap and small cap. We have a weekly Danger Zone report. We put specific companies in just last week, WhiteWave Foods. Understand how their profits are misleading and how dangerous the valuation is. We'll walk you through, we'll walk you through what the catalyst is. We'll walk you through how this company compares to peers. Suspended Ratings is an article we recently did pointing out that, you know what, there are times when the financial information available in the marketplace has no longer become reliable or indicative of the risk-reward of the stock. We're upfront and honest about that. You don't get that from other research firms. We'll talk about Danger Zone highlights and lowlights. All right? You know, so the lowlights were the stocks that actually were our danger zone calls were not good in 2015. But you know what? They've been awesome in 2016. We also have articles talking about why you can't always trust the traditional metrics. And we'll go into great statistical detail about why that happens. Then we have forensic accounting where you can go in and get access to dashboards that show you all kinds of forensic accounting stats you can't get anyplace else. We do the same for ETFs and mutual funds. Every quarter, we identify the best and worst sector funds, the best and worst style funds. We do sector ratings. We have a unique methodology that focuses on the underlying holdings in these funds. So we, you know, we've got some institutional clients, whether you're an endowment fund or a big family office, and you've got money split amongst a lot of managers. How do you know where the risk is? How do you know that they know where the risk is? Right? That's where our ability to go in on a security-level detail exactly how much risk-reward is involved. So this strategy sounds easy. Why, why am I making a big deal of this? Why is New Constructs in existence? Well, it's really not as easy to execute as you might think. There's a lot of work that goes into getting the real measure of cash flows and return on capital. Right? MarketWatch pointed out In August last year, 20% of CFOs admit they fudge earnings by more than 10% or around 10%. Sell-side analysts don't detect it. I meet with sell-side analysts on a regular basis. You know what they tell me? They don't get paid to do that kind of work anymore. You know what they get paid to do? Arrange meetings with management. The Financial Times did an exposé on a Wall Street analyst who confessed that Buy ratings are not really buy ratings. No ratings really matter. Your high-end institutional investors, they know this. They know you should ignore Wall Street ratings. Maybe not everyone else. My point is, the information that comes out in the marketplace is not always reliable. I think there's really sort of no better example than our buddy Jim Cramer. There's a lot of noise. Stocks— stock research and recommendations are biased and incomplete. There's a lot of noise out there. And it's not because these folks are all bad, bad people. It's a lot of work. This is the average length of a 10-K filing or an annual report. It's super long. We're talking more than 200 pages and it's getting longer. It's very difficult to do the work required to get to the real cash flows. And it's only getting more difficult. Look, I work directly with regulators. And standard setters. And I can tell you that the businesses are more complex. Accounting is going to get a lot more complex. There's going to be a lot more disclosures, which is good. And the standard setters are moving us in the right direction. But it's— there's more complexity, my friends. These filings are going to get longer and more difficult. And guess what? There's no substitute to doing that work if you want to understand cash flows. You know, and don't just take my word for it. We've got some of the top clients in the world, whether it's Wells Fargo, Interactive Brokers, Barron's uses our research all the time, Ernst Young, USA Today, Merrill Lynch, Raymond James. Most of your top-end brokers are clients of New Constructs. If they're not, maybe you should ask why. What do they do to ensure that they don't get burned by something in the footnotes? Also, take a look at our past performance. Right? It's there on our website as well. The link in this PowerPoint will take you straight to that section of our website. In fact, I'll jump to that real fast. Past performance tracking. Stats and charts. Here's how our long-short does versus the risk-free rate. Very good. Here's how our attractive stocks, large and small cap, large cap and small cap, have done versus the S&P 500 and the Russell too. The takeaway is we outperform. What makes it unique as to what we're doing? Well, we're getting deep into the details. This is a chart showing the items that we're pulling out of the MD&A, Management Discussion and Analysis. And I want to point this out to you because XBRL doesn't work in the MD&A. Most data collection firms aren't even looking at the MD&A. And you can see we're finding a lot of unusual gains and charges that distort income statement results. You wouldn't know that these— that the cost of goods sold or SG&A is distorted by these unusual items unless you read the MD&A. We cover about 3,000 companies, and we're— so we're finding about, on average, one major unusual hidden item per company. So they're out there, right? Asset write-downs, they mess up the balance sheet. The balance sheet is important to understanding not just cash flows, but how much cash flow relative to the amount of capital in the business. Remember, both are important to understanding return on invested capital. Write-downs are a big deal. We found over almost 33,000 of them in the last 5 years. It happens, right? And we're not just collecting data, we're putting a story together. One of my favorite stories that was really kind of data-driven and obvious, in retrospect of course, was Eastman Kodak, right? In March of 2011, I wrote an article called Dead Stock Walking, and it was based on the fact that Eastman Kodak had used a return on plan asset assumption for their pension plan, or the assumed return for the pension plan assets, of 8.7%, the single highest assumption of all publicly traded companies in 2010. That allowed them to boost revenues by 2.2% and earnings by many multiples more than that. Even though the pension plan was underfunded by $2.6 billion or 3 times the market cap. Talk about misleading earnings, robbing Peter to pay Paul, robbing employees to pay executives. At the same time, the stock price had a valuation that implied profits were going to grow 10% compounded annually for 11 years. Easy call when you have this kind of data, right? Right. And guess what? We were right. Took the market 9 months to catch up. Sometimes it takes a while for the market to catch up to what we do. I don't mind that. I think it's better, better to be trustworthy and better to do what's right than fall prey to sort of the market popularity. One of the slides that some of our friends at the regulators loved the most was this early indicator for fraud. What was it? It was write-downs, right? For Dynergy, in the 3 years prior they got busted for fraud, they had 16 write-down charges equal to $3.85 billion after tax. What did that mean in layman's terms? For every dollar of assets on the balance sheet, these guys have written off $3.46. Ouch. It's not exactly creating value. Watch out. So what we do works on an individual company level. It also works in the big picture. This is some work we do for some of our consulting partners. We help them identify what's most strongly correlated to market valuation. And guess what? It's return on invested capital. Return on invested capital explains about 63% of the changes in market valuation for S&P 500 companies. We can drill down to smaller groups of companies, and it's still a super strong correlation. 59% in this situation. Our models are the best in the business. This is a quick summary of our models, right? For every company, if you're a free user or whether you're Gold, Platinum, or Pro or Institutional, you get access to this kind of detail on an individual company basis, right? You can go in and see exactly what drives our overall rating. Quality of earnings and valuation are the 2 overall drivers. Right? And we're going to look at quality of earnings through 2 lenses. How do the economic earnings compare to the reported earnings? Are they being like Eastman Kodak and showing a misleading trend where accounting earnings are positive and rising when the economic earnings are negative and declining? We'll highlight that for you. We'll highlight it when it's good too. We'll also look at return on invested capital. How much cash does this company generate relative to the amount of cash that's been invested in it over its life? We've got 3 valuation metrics. All of these are defined on our website in the education section. But free cash flow yield, that's your real dividend yield. That's the real number you can take to the bank. Price to the economic book value ratio— economic book value is different from accounting book value that it's based on cash flows. And it's the no-growth value of the business assuming the cash flows stay the same forever. When it's 1.0, Effectively, the market is saying it believes that Intel's stock price is equal to the no-growth value of the business, or there is zero growth priced into the stock as of this date at that price. And the growth appreciation period is a dynamic discounted cash flow modeling tool that we also use to drive our ratings. So free resources, free research, sign up for our site. And you get alerts. You get access to reports, long ideas, danger zone ideas, best and worst ETFs and mutual funds. Not all of these are available if you just sign up for free on the day we publish, but eventually you get access. There's free education, tutorials, and models, right? You can see our models in terms of tutorials where you can see we truly have the best models in the world. So going through some of the resources that I mentioned before, if you're on our site and you want to get access for a lot of these links that I mentioned— see, I can share the screen a little bit here and make this a little bit easier so we can go straight to So investment research, that's where you can get access to the most attractive stocks, right? This is February's report. Most dangerous stocks, the long ideas, right? 10 stocks to get you through a bear market. There it is, free, 10 of them, ideas, right? Built on concepts that have lasting value. Remember I told you the high ROIC stocks performed best in 2008? Here's the report identifying, detailing what these stocks are. There's always data behind what we do, not belief in the Greater Fool theory, right? I'll never forget being on CNBC once talking about Netflix and how expensive the stock was and how it implied effectively that the company would have to grow profits at 25% compounded annually for over 2 decades. And the guy on the other side of the argument On CNBC, on live TV, said, oh, profits don't matter. Well, I think we're finding out in today's market, profits do matter. Profits do matter. And we're gonna show you how to measure profits. Also, on the long ideas, you're gonna get specific, specific ideas on specific stocks as well on a fairly regular, on a regular basis. When it comes to the most— on the dangerous side, here's our danger zone, right? WhiteWave Food Company was there. It was there last week, suspended ratings. Going into kind of the real detail and rigor we provide, especially as it relates to filings that you can't always get access to or acquisitions. Our analysts are pouring through thousands and thousands of data points every day. And we bring that to bear in our ratings all the time. So we suspend ratings when things don't always make sense. Danger Zone lowlights. You know, I mentioned that before. I thought that was a great concept. And I love this article because, you know, these are some stocks that did well during Danger zone stocks that did well in 2015 but are getting crushed so far this year. And that trend is only continuing. It's really where I think we're sort of starting to weed out some of this pure momentum stuff in the market. I'm starting to get some questions here. Feel free to add or throw in some questions as well if you'd like. I got a few more minutes I'm going to dedicate to questions. I'm just curious, Let's see. And here's another great resource in terms of really giving our clients access to the truth, especially when it comes to ETFs. How much quality is in the high-quality ETF? Well, how do you measure quality? How do you measure cash? How do you measure risk? We're honest about that. We're going to give you that answer. You know, and for this situation, we found that this high-quality ETF had a lot of very low-quality stocks in it when you look at fundamentals. And I think fundamentals are mattering more now than they have in a long time. The problem with using accounting book value. 4 reasons ROE is not a useful metric. Operating leases. YPE ratios are not a good measure of value. Right? Because earnings is not a really good measure. Look at the regression analysis compared to what you get when you look at return on invested capital. One is not very good. One is terrible. One is actually pretty good. All right, I'm going to take a couple questions here. What's the one metric if you're going to be looking at new constructs? I think the one thing you want to look at for new constructs, you know, if you want to simplify things, it's our risk-reward ratings, right? It's what's the rating, right? Now, you need to know, you need to have— want to be able to log in and see for Apple, we have an attractive rating, but the rating is suspended because we believe that this abnormally high ROIC is unsustainable. Something I believed for a long time, but it's beginning to look like sentiment is finally sort of starting to catch up with Apple. People are not just sort of looking at the glass half full all the time for Apple. And that means this abnormal ROIC is going to come crashing down, or people finally recognize that. And then there's a rating detail that I mentioned before. I think it's also important to show our models. When we get the best models in the world, for understanding profitability and valuation. We have people that pay us just for access to our models. Now, this is part of the institutional service. You can't get it directly through the site. It's significantly more expensive. And, you know, clients are paying thousands of dollars a month for access to a tool like this because it's, it's very difficult to replicate, right? You're going to be able to access all the metrics going back many years, in this case 2002 for Accenture. You can see return on invested capital, NOPAT, invested capital, free cash flow, economic earnings, the economic book value per share, economic book value calculation. We're going to show you reconciliation as well. How do you go from net income to NOPAT, from NOPAT to economic earnings? We'll do it on a per-share basis. Also, so you can see all the adjustments we make on a per-share basis. We'll summarize it on the adjustments page. See all the income statement adjustments. You can see all the balance sheet adjustments. These green dots mean you can change items. We used to have a green dot next to everything, then we changed some things on our site and we decided, you know what, instead of having all these green dots, and we left a lot of them in there, we're going to have a plug override. So you can just basically override anything, right? You just dislike a bunch of numbers, there's one spot you go in and change it. We're not selling religion, all right? We're just doing all the work that you don't necessarily have the time or interest to do by collecting all that data. You can also click through to the original filings, right? So if you want to see, oh, where's that income statement they say they— ah, interesting. Where are these non-recurring items they say they got? Ah, that comes straight from pension settlement charges. That comes straight from the income statement. Interesting. Are there any charges that don't come from the income statement? Oh, here's one, the hidden items. Wow, this looks like it could be a big one, but you don't know if that's in thousands or millions, so you got to go to the note. It's on page F-12, could be page 112, you don't know because companies like to change the numbers up so it doesn't look like the filing is as long. So it looks like this value, let's see if we can tell if it's in thousands or millions. You have to go through the note. Hard to tell, but basically release of provision for doubtful accounts. Unusual gain, right? Found on page F12 or however long it is. The point is all the data is there for you to actually see exactly what it is we do. 100% transparency. Same is true in the valuation, right? You get the— you have the ability to look at multiple forecast scenarios. You can see the discounted cash flow model that we use to quantify expectations in this case. This is exactly how we, how we do it here. The revenue estimates, revenue growth, the pretax profit, profit margin, the cash tax rate to give you the after-tax profit margin and after-tax profit. Subtract incremental working capital and fixed assets to get the overall change in invested capital. That gives you free cash flow. Find the present value of free cash flow out into the future. You accumulate that. You look at a terminal value. It's a no-growth terminal value that we have. That gives you the present value. Then you get the present value of the terminal value. You get the corporate value, which is sort of similar to enterprise value. Then you have to adjust it down to shareholder value, or really the implied market value, which you divide by shares outstanding to get the implied stock prices. And then you can create different scenarios if you want as well. So like, for example, here, if we wanted to look at Accenture, we could create an optimistic scenario. That assumed a higher growth rate and a higher margin going forward. So let's just say for fun, we want to say, let's say growth is 5% in the next year, and then it goes up to 10% out for 5 years, and our margin is, is, um, 15% instead of almost 14%. We save that off. And then when that's saved, we have a new decision page scenario that we can share. And you can see instead of 17 years under the old default scenario, which is the blue line, you have a slower or lower growth appreciation period because you got a faster growth rate and higher profitability. So you're creating the cash flows at a greater rate, or creating the cash flows embedded in the stock price at a greater rate. If you want to look at your target price and understand what you have to believe in to justify that price, we show you that as well. So it's 14 years of 7% growth with a return on capital versus cost of capital spread of 51%. Anyway, 100% transparency behind everything we do. These are the best models, and these are the models that drive the ratings. And that's the best. What makes ROIC better than PE, ROE, ROA, etc.? That's a great question, and we've got a special section on our site focused on that, focused on ROE, right? Check out the education. I mean, it's all— it's really the idea is that it's all here for you to see Exactly what goes into what it is we do. And we want to be transparent about that so you understand how much work we do for you. You know, one, I think if you want to really get the background on New Constructs and what makes it special, this article, ROIC: The Paradigm for Linking Corporate Performance to Evaluation, This really goes through why what we do is unique, why no one else has done it, and why what you're getting from New Constructs is more reliable than what you get from other folks. And, you know, we wrote a white paper on this because I felt like it was time for us to really put this into words in a way that made it easy for people to understand. Yes, return on invested capital is applicable to all companies is the one version of the truth, whether it's a utility or a bank. We do the work to create one version of the truth. This is what I did when I was on Wall Street. It's what I did when I was an executive compensation consultant. This is what I've been doing for 20 years. One version of the truth, apples to apples, because at the end of the day, I believe that there is one version, should be one version of the truth, because in principle, all companies Should be measured based on, very simply, how much cash flow they generate relative to how much capital has gone into them over their life. Now there are many different accounting terms for those measurables. That's what makes it hard because accounting disguises— because accounting is complex, because businesses are complex. You got to have a lot of names for all the different things so you can distinguish between them. But at the end of the day, it all boils down to how much cash flow does a business generate Relative to how much capital has been put into the business over its life. That's what we specialize in measuring, and that's why we do a better job of helping you find safe stocks and avoid dangerous stocks. That's the strategy. We help you understand what's safe. I think we're more transparent about that. We're more honest about that. We aim to be, right? Better understand what is safe, better understand what is dangerous, better understand how to find safe stocks, better understand how to find the dangerous stocks, right? I mean, you're not looking to invest in them, but you need to know where they are and know where the list is so you can make sure you're not in them. Find safe funds and ETFs. We help you do that too. From a bottoms-up perspective. And you're not gonna get this from other people. There's a lot of noise out there. People, the last thing they want you to focus on is the truth because you know what? It's a whole lot harder to sell you stock if you know that the business isn't profitable. And it's hard work. The accountants, the regulators aren't keeping up with it. At the end of the day, check out our performance. I've covered it before, but the performance that we have is very strong. The clients we have, very strong. So how to protect your portfolio. Please feel free to hit us up on Twitter, @NewConstructs on Twitter, on Facebook, StockTwits, Seeking Alpha. Email us at publishing@newconstructs.com if you want a copy of this presentation. We're happy to share it. Thank you very much for being with us today, and we look forward to seeing you at our next webinar. Thank you.