Letting Winners Run – Steven Cress On Alpha Picks’ Outperformance

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Seeking Alpha’s quant guru Steven Cress talks about why Alpha Picks is up 100% and lets winners run (1:00), how to trade a huge winner like Super Micro (11:05) and how an alpha portfolio can bring income as well (16:00).

Transcript

Kim Khan: Welcome to the Investing Experts Podcast. I’m your host, Kim Khan. And today, my guest is Steve Cress, the Head of Quant Strategy at Seeking Alpha.

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And don’t forget, if you’re looking for a comprehensive look at what’s going on in the markets each day, we have our Wall Street Breakfast Podcast out before 7 A.M. Eastern Time, and our follow-up Wall Street Lunch up at noon. You can find them at Seeking Alpha, or wherever you get your podcasts.

Steve, great to talk to you again.

Steve Cress: Thank you so much for having me back on.

KK: So, we’re here today to talk about a milestone crossed by Seeking Alpha’s Alpha Picks portfolio. But I think that we should first get a little overview of what Alpha Picks is. Steve, can you tell us a little more about this quantamental portfolio that we have?

SC: Yeah, we did. It was quite a milestone that we achieved. The Alpha Picks portfolio is now up 114% versus the S&P 500, which is up 32% from a starting point of July 1st, 2022. That is when we launched the product. And the performance has been absolutely fantastic.

Wasn’t always that way in the beginning, a bit of a rough road, but that’s how it is when you put new ideas into a portfolio. You’re looking at the optimal mispriced securities. And when a security is mispriced, it doesn’t always trade smoothly. But eventually, these companies that we focus on have awesome fundamentals, and investors find them and buy them. And hence, where we are a year and a half later, with a return of 114% versus the S&P at 32%.

So, I’ll tell you a little bit about how Alpha Picks works. It’s a platform that we run that is based on Seeking Alpha’s Quant Strong Buys. And on this platform we just try to make people’s lives really easy. So we’ve selected what are the best SA Quant Strong Buys, and we issue two recommendations per month.

So on any given day, there could be about 400 Strong Buys from the Quant System, and we’re selecting the two best stocks on a monthly basis. So on the trading day that is closest to the first of the month, and the 15th of the month, we send out an email to our subscribers, or they could also go on the platform that we have for Alpha Picks, and it’s a very transparent platform. It shows when the stock is picked. We have an analysis section, which actually has an article on each pick.

And it takes a little bit of a deeper dive into the fundamentals of the company and the growth drivers. We have a portfolio section that shows what our purchase price was, the return, the return versus the S&P 500, and the weight that it has in the portfolio. So very, very transparent. And then we have a performance page that shows everything that is current, or closed in the portfolio, and the returns and the date it was picked as well.

So the way our strategy works for Seeking Alpha Quant is it’s based on five core metrics. We look for stocks that are collectively strong on value, growth, profitability, analyst EPS revisions, and momentum.

With Alpha Picks, we have additional criteria, so we can filter out the very two best stocks. And some of those additional criteria are making sure that any stock that we select for Alpha Picks has to be a Quant strong buy for at least 75 days. We’re looking for stocks that are U.S. common stocks, or ADRs. They can’t be REITs. They have to have three-month average market capitalization that’s greater than $500 million. The stock price has to be greater than $10.

And once we recommend a stock, even if the fundamentals are very strong, we will not recommend it again until a full year has passed. And now that the product is about a year and a half old, there are actually two companies where we have added to the portfolio again because the fundamentals have remained very strong, which is Modine Manufacturing (MOD) and (MHO), M/I Homes.

So we find with some of our competitors that their list could be the same month-in and month-out, and they’re always recommending the same stocks to people. We’re very transparent, and we set up rules because we don’t want to be issuing the same recommendation over and over again, hence why we have that rule in place.

So whenever a stock is admitted to the portfolio, if there’s a rating change, we dispatch an alert. So if it goes from a strong buy to buy or hold, an alert would go out. Even if a company has like a good quarterly report, we’ll send them an update. If a stock is up 5% or 10%, we’ll send an update, which people can find on the analysis page. But the core of the Quant System and the Alpha Picks system is really additional parameters and criteria that we have on the Seeking Alpha Quant system.

And as I mentioned there, we’re looking basically at a GARP approach, growth at a reasonable price, and we’re sticking with that. We have the added metrics of momentum in there, as well as the analyst EPS revisions, and those are the standout features that have helped us achieve really superior performance. And what we find is whether the markets are in a corrective phase, or they’re skyrocketing, sometimes the market will trade on sentiment that could be in reaction to a state of fear, and there are opportunities there.

But investors typically always return to companies with good fundamentals. And that’s what we do with Alpha Picks and with Seeking Alpha Quant in general, is we’re looking for stocks that have excellent investment fundamentals on the metrics that I have mentioned.

KK: Well, I was going to say, you like letting winners run, don’t you?

SC: That is really good point. So part of the strategy is when we have a stock that is up 100%, typically we will remove a stock if it drops to a hold after 180 days. So it’s a very long-term approach that we have. A stock can come in as a strong buy, and it could drop down to a buy or a hold. And even at a hold, we’ll maintain it in the portfolio for 180 days. After 180 days, if it’s still hold, we typically feel it could be dead money.

However, when we have stocks that have doubled, that are up 100%, and I’m really glad that you mentioned that, because of the 30-odd-plus names that we have in the portfolio, seven of the stocks are now up over 100%. If those stocks were to drop to a hold, we would only sell half the position after 180 days, and we would just keep the rest on the table until the stock eventually went to a sell or a strong sell.

But this part of our strategy has proven to be very, very successful, and the reason why is sometimes with a company like Super Micro (SMCI), which is up 1,000% since we recommended it on November 15th of 2022, the valuation will tend to run up, and if the valuation runs up, that could be a trigger that will bring a company to a hold recommendation. So we have factor grades that we look at. So if you’re familiar with Seeking Alpha Premium and the Quant, you’ll know that we have grades from A+ to F.

And we apply those to growth, value, profitability, EPS provisions, and momentum, and those grades are sector relative. So when you’re looking at a value grade that is an A, you know that company has a much better value than the rest of its sector. If you’re looking at a growth grade that could be an F, its growth is much lower than the sector. And what will happen on the value side is if a grade moves, say, from a D+ to a D-, and the company was a strong buy, that will trigger it to automatically going to a hold.

But the fundamentals could be very, very strong for a company. So that’s why we don’t want to unload it just because it drops a hold. A hold is a hold. It’s not a sell.

So with our winners, if a stock is up 100%, we decide that, okay, this company is really doing something well and will be a little bit more tolerant than that 180-day period. And it has proved to be very successful, because what happens often is sometimes earnings estimates will be increased, and all of a sudden the P/E will start to look more attractive, and the value grade will start to look more attractive. So it may go from a D- back to like a C-, or a C, and the stock can go back to a strong buy.

So yeah, we have about 30 stocks in the portfolio. We have Super Micro Computer up 1,000%. We have Modine Manufacturing up 283%. We have M/I Homes up 232%. We have Alpha Metallurgical Resources (AMR) up 193%. Powell Industries (POWL) is up 183%. Abercrombie & Fitch (ANF), which we just put in the portfolio in October, is up 110%. Uber (UBER), which we put in last June, is up 109%.

And then we have a company like BlueLinx Holdings (BXC), which is up 63%. At one point, for a good six months, that was our worst performing stock. It was down about 30%. But the fundamentals continue to look good. Here’s another stock that did go to a hold at one point. But the fundamentals remained intact. And then the investment community sort of discovered the stock. And looking at it on a growth and profitability basis, they finally started investing in it. And now the stock is up 63%.

The model has done an excellent job on picking companies. We have a fair number that are up over 40% as well. Between 40% and 100%, there are actually eight companies that are up between 40% and 100%. And then we have seven companies that are up over 100%. So, it is doing exactly what it says on the tin, selecting companies with great investment fundamentals and employing our systematic strategy to identify these stocks.

KK: Well, let’s go into Super Micro, which you mentioned a little more. It’s the darling of the portfolio. As you mentioned up a 1,000%. I dare say it’s the darling of a lot of portfolios right now. Stock’s up 180% since its pre-earnings low at January 17th. So in less than a month, it’s nearly doubled. And for a stock that’s trading at $900 right now, I mean, that’s an extraordinary move.

And we’ve seen similar moves with the chip frenzy, big moves in Arm Holdings (ARM), a lot of hype going up coming in to Nvidia’s (NVDA) earnings next week. I wanted to ask you what you thought of this kind of action? And also just how important Nvidia’s earnings are to this whole run that we’ve seen so far.

SC: Well, Nvidia is a little bit of a different company. Their entire focus really is on these powerful chips that they have that let AI perform in the fashion that it’s supposed to. I guess Supermicro is similar as well in that they have chips, but they also have high-performance storage solutions and high-performance servers as well.

So the companies are a little bit different, but yet very similar in that they’re in the same industry. I think the important thing is really making decision for a stock that has run so much. Do you continue to invest in it? And we often get this question because momentum is one of the core factors that we have. And I believe innately people are afraid of momentum.

Stocks that are near 52-week highs, the feeling is usually that they missed it. And I often encourage people not to pay attention to a 52-week high at all. If a stock is up 5%, or 1,000% in the last year, you need to look at a company’s valuation and growth rate in order to make your investment decision. It’s not that the stock has made a move up or down. So it’s really important to look at the valuation framework and the growth framework.

So when we’re looking at Super Micro Computer right now, the valuation grade is a D. The stock is still a strong buy. If the valuation were to go to a D-, it would set off a trigger that would force the rating to a hold from a strong buy. But the growth grade is an A+. The profitability is a B. Momentum is an A+. And analyst revisions are an A-. So again those are all sector relative. So on each of those factors, it’s much stronger versus a sector.

What I will add on the valuation is when you take a sort of a deeper dive, you could look at the underlying metrics such as P/E, trailing or forward, GAAP or non-GAAP, EV to sales, EV to EBITDA. There’s a lot of metrics that we have. Some are in the C category, some are in the D category. But one of the more important metrics is the PEG ratio.

And I love PEG, that is valuation and growth rate combined. So it’s a very unique metric where you can look at the valuation structure of a company and the growth structure of a company all in one metric. And that PEG ratio is an A-. So, if you’re looking at that valuation metric, the company still is very, very attractive when you’re combining the growth and value together.

So right now, the stock is still a strong buy. And even if it were to go to hold, I would tell people to continue to hold this stock. Sometimes when you go into quarterly periods, and this company just reported, they had great results. But analysts sometimes take a little time to up their estimates. And once they up their estimates, all of a sudden, you’ll find P/E ratio, forward P/E ratios could change, and the stock could all of a sudden be attractive.

As you mentioned, the stock is up since the beginning of January, almost 150%. At the end of January, they reported their numbers and they beat on both the top and bottom line side. And guidance was significant to the upside as well. Hence, the stock just went on a tear. And it’s the first stock that we have in the portfolio that’s actually up over 1000%.

So, we’re usually really pleased when a stock is up over 100%. We have seven of them. But Super Micro is now up 1000% from when we recommended it in November of 2022.

KK: So also in your portfolio, you’ve got Meta Platforms (META), which surprised some people with coming out with their first ever dividend and big buyback program. I wanted to ask if you thought, well, first tell us how dividends factor in, if they do at all, into Alpha Picks.

And also if you kind of saw a trend in these larger companies, the tech companies that don’t pay dividends, like say Alphabet (GOOG) (GOOGL) and Amazon (AMZN), if they may be looking into returning cash to shareholders later on this year?

SC: Yeah, so we actually, you know, we’re not looking for dividends in Alpha Picks. Having said that, there are a number of companies that do pay dividends and it’s an added benefit. Most of these companies have a tremendous amount of cash. And when you do have a tremendous amount of cash, and you can’t necessarily put that cash to work, you’ll often start to pay a dividend.

So, in Alpha Picks right now, out of the 30 plus stocks, looks like we have about 14, so little less than 50% of them pay dividends. And some of them look pretty high. Like you have Manulife (MFC), which has a forward yield of 4.7%. You have Ardmore Shipping (ASC), it has a forward yield of 3.94%. You have Valero Energy (VLO) with a 3% yield. You have HF Sinclair (DINO) with a 3% yield. You have Comcast (CMCSA) with a yield of 2.95%.

And the reason why I mentioned those is all those yields are actually above the S&P 500. So I don’t pitch this as a product that focuses on capital appreciation and income, but certainly you could almost make a case for it being that close to half the companies do have a dividend. And some of those yields are really super attractive compared to the S&P 500.

So Meta is in the portfolio, as you mentioned, and Meta came into the portfolio last August, August 15th, 2023. And it is up 56% since we have added it to the portfolio. Now the S&P for the same period is up only 12%. So it has an active return over the S&P of 43% since we added it. So a lot of people, like when we put Meta in, they’re like, oh, the stock has already had a huge run up from the previous year. It’s a name that a lot of people know. I’m kind of agnostic to that.

We want stocks in a portfolio that are going to go up. And we have two that I mentioned that it surpassed a one-year period and the investment fundamentals were excellent. So we added the shares again for Modine Manufacturing and M/I Homes. And from the point that we recommended them the second time, they have done very well.

So when we take a look at M/I Homes, we entered that into the portfolio for a second time in December of 2023. That one is fairly flat from that period, but we believe the fundamentals are still strong. But when you look at Modine Manufacturing, we added that. It was our first pick for the year, this year in 2024. And Modine Manufacturing is up 31% year-to-date. So again, we’re looking at investment fundamentals. And clearly, that was a good choice to submit to the portfolio again.

KK: And so as we kind of approach a little fast the midway of our first quarter, I wanted to get your thoughts on just how the market is looking overall. We’ve had a lot of talk about the concentration in the market, how the top seven, the Magnificent Seven, have been dragging the broader market higher.

Do you see a more democratic market in a sense in the future? Or do you think that these big names are going to keep going maybe through mid-year?

SC: The names, it’s interesting. In 2022, if you looked at the Magnificent Seven, the stocks were down about 39%. So they’re actually down more than the market. So the Mag Seven had an awful 2022. 2023 was a bit of a reversion to the mean. They not only made up lost ground, people were highly nervous going into 2023 in terms of what the Fed was going to do, inflation, interest rates were going up, people didn’t want to own bonds.

And in that kind of environment, you’re quite nervous there’s going to be a recession. So there was sort of a flight of capital to safety during 2023. And you had people attracted to the Mag Seven because they’re highly profitable companies. So with a combined sort of reversion to the mean and the flight to safety, and then you had sort of a third component, which was AI, and most of these — the Magnificent Seven are technology companies, all are involved with AI. It sort of was a trifecta win for the Magnificent Seven in 2023.

When you look at the seven stocks, they were up 111%, which is almost unprecedented to have your seven largest market cap stocks up 111%. These are huge companies. Literally, like you can make the claim, they’re bigger than the size of California when you’re looking at their market caps.

It’s always a fun analogy to make. But it’s highly unlikely. The standard deviation there is very, very remote that you would see that same kind of return again. And also the stocks, because of that run up, they’ve become very, very expensive. If you look at our Quant grades for valuation, most of them are Fs and Ds.

Now, there is Google and Meta, which we actually do have in the Alpha Picks platform, and they actually have the most attractive valuation frameworks out of the Magnificent Seven. Hence, with their growth and profitability, our systematic process actually did identify them. And the stocks, as I mentioned before, the performance has been really strong for Meta since it’s been added to the portfolio.

Now, as we enter into 2024, we’re looking at a potential scenario where there’s no apparent threat from the Fed or the central banks that they’ll continue to move rates up. The story now is, how long will they hold them? And is there the potential that rates will actually come down?

So in that kind of environment, investors feel more comfortable with risk. And since they’ll be more comfortable with risk, and we’ve already seen this start to play out, they’ll start investing in some mid-cap companies and small-cap companies.

Now, it was a brief trend that took place during November and early December that we did start to see a rotation. Then there was a little bit of a flight of capital coming back into the Magnificent Seven stocks and safety. But I think as we get closer to the market feeling comfortable, that rates won’t be going up, that they might be coming down in the second half of this year, or eventually in 2025, the recession scenario is fully discounted at this point.

You should see the market rotating to other stocks, which would benefit the Quant System overall. Having said that, investors are quick to pick up to the stocks in Alpha Picks. They do have very strong fundamentals, hence the reason why the returns have been so well.

And being that we’re in the quarter right now, I think I’ll add, we have had almost 20 companies report in the Alpha Picks portfolio for the quarter. And in each of these cases, all but one of the companies all beat analyst expectations to the upside. So that’s part of the reason why we’ve had such a stellar month for January.

We had a stellar November and December as well for Alpha Picks, but all of the companies that have reported so far, only one of them did not beat expectations. The one that did not, unfortunately, was M/I Homes. They were a little soft and the guidance was soft as well from the CEO, hence the stock has actually been flat. So flat is actually not so bad. When you have stocks that are appreciating as much as ours, you can have one stock that’s flat.

KK: So as we wrap up, any listeners who’d like to take a look at the full Alpha Picks portfolio and test drive the service, can go directly to seekingalpha.com/alpha-picks. And Steve, thanks again so much for your time.

SC: Yeah, I really appreciate it. And yeah, feel free to take a look at Alpha Picks, very transparent system, as I mentioned, up 114% since inception in July 2022. And if you’re looking for just two good ideas a month, this is the platform to go to.

KK: Thanks for listening to the Investing Experts Podcast. Nothing on this podcast should be taken as investment advice of any sort. At times, myself or my guest may own positions in the securities mentioned. For full access to transcripts, as well as analyst ratings, stock Quant scores, and dividend grades, subscribe to Seeking Alpha Premium at seekingalpha.com/subscriptions.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.