Best Stock Selection Requires Clear Comparisons

Readers familiar with our work may want to skip to the Comparing Details heading below.

This article rewards investors who choose to direct their investments of TIME and capital to those alternatives with the highest likelihood of successful rates of return among ones compared under identical important measures. Now Patrick Industries, Inc. (PATK) provides attractive answers to these questions:

  • What alternative choices are available?
  • Which have the best trade-offs between forecast-able reward and risk?
  • How big a reward is realistic to expect? Why?
  • How often may disappointment occur?
  • How much time and capital may disappointment involve?
  • How frequently may the rewards expected be compounded?

These are questions often neither asked nor answered by many investment analysis reports. The commonplace approach is to present those aspects of one investment which may set it apart from others, but fail to make the essential decision-supporting step of comparing alternatives on an equal-measure basis.

If your thoughts about comparative values lead to P/E ratios, do you really believe in “generally acceptable accounting practices”?

Do you really believe that multi-year, competitive share-of-market forecasts can be made in today’s rapidly advancing technology environment without error provisions – provisions carried forward into the G of P/EG value assertions?

Instead, look to demonstrated human-nature behavior of self-protection. “When the oxygen masks come down, be sure to put yours in place before attempting to help others”.

That is the perpetual work environment of investing Market-Makers [MMs] whose role is to aid buyers and sellers find a point of price balance right now in multi-million-dollar block trades. A balance which usually requires them to put a part of their own firm’s capital temporarily at the risk of changing market attitudes and prices.

They won’t do it without the oxygen of price-change protection. That insurance comes from separate hedging deals in derivative securities where the operating leverage of the limited-life legal contracts involved makes deals practical.

What must be paid for the protection, and the way it is provided tells just how far those (sufficiently) in the know realistically expect prices may go. They all have real-money bets being made. Price range forecasts over time periods defined by the derivatives contract lives are involved.

Such forecasts are constantly being refined every moment investment markets are operating, and are made part of every market-day’s closing records. They provide an historical record (in subsequent market price actions) of how well the “smart money” can make useful forecasts – for specific stocks, ETFs, and indexes.

To get answers we look to the best-informed market participants – the market-makers [MMs]. These are the dozen to two dozen firms providing price quotations to exchanges and transaction systems as a result of their extensive 24×7 world-wide information collection systems and evaluation resources. It is a community of perhaps 100,000 employees. The largest, Goldman Sachs employs over 35,000 full-time.

Present-day markets are driven by major investing organizations commanding multi-billion dollar portfolios with stock contents which can only be adjusted by negotiated volume (block) trades between peers, not by “open auction”. Such trades set and move posted prices.

The individual investor typically is merely along for the ride. He/she needs to have a sense of where the negotiators are likely to head, pricewise. Conventional analysis often provides superficial descriptions and little linkage between operating minutia and price forecasts. As examples here is how Yahoo Finance reports on IR:

Description

Patrick Industries, Inc. manufactures and distributes building products and materials for the recreational vehicle, marine, manufactured housing, and industrial markets in the United States and Canada. Its Manufacturing segment manufactures and sells furniture, shelving, walls, countertops, and cabinet products; cabinet doors, fiberglass bath fixtures, and tile systems; hardwood furniture, vinyl printing, solid surface, granite, and quartz countertop fabrication products; RV paintings; fabricated aluminum products; decorative vinyl and paper laminated panels; fiberglass and plastic components; softwoods lumber; custom cabinets; polymer-based flooring products; and electrical systems and components, including instrument and dash panels, and other products. This segment also provides wrapped vinyl, paper, and hardwood profile moldings; interior passage doors; slide-out trim and fascia products; thermoformed shower surrounds; specialty bath and closet building products; fiberglass and plastic helm systems and components; wiring and wire harnesses; aluminum fuel tanks; boat covers, towers, tops, and frames; CNC molds and composite parts; and slotwall panels and components. The company’s Distribution segment distributes pre-finished wall and ceiling panels, drywall and drywall finishing products, electronics, audio systems components, appliances, wiring products, electrical and plumbing products, cement siding products, raw and processed lumber, fiber reinforced polyester products, interior passage doors, roofing products, laminate and ceramic flooring products, shower doors, furniture, fireplaces and surrounds, interior and exterior lighting products, and other products. This segment also offers transportation and logistics services. Patrick Industries, Inc. offers its products through a network of manufacturing and distribution centers. The company was founded in 1959 and is based in Elkhart, Indiana.

We Picked on other stocks “People also watch” for comparisons

Figure 1

Wait a bit! These comparisons are coming from Market-Makers [MMs]? On stocks with market capitalizations of $1-$2 billion or less, (column [T] ) while most of SA’s readership interest is on $100-billion issues. What interest could MMs have in these dogs?

Take another look at column [U], the proportion of these stocks now held by institutions: upwards of 90% in most cases. The institutions are constantly looking at opportunities to build portfolio wealth, and evidently they don’t overlook small-caps. But their everyday market volumes tend to be small, so it takes MMs to negotiate the block trades needed to make a difference in institutional-size $billion portfolios.

Our interest is perked when a small-cap is priced at a Range Index point which has previously produced big, prompt, reliable capital gain payoffs, competitive with the best of the larger (2,600+ stocks) in the MM forecast population.

Which is where PATK is now. So read on.

Comparing Details

The essence of valuation is in comparison, which requires that the compared measures be as close to identical as possible. To that end we place all of our valuations in a carefully defined set of measures, and describe them in as parallel set of comparisons as is possible.

What is important to us in this analysis is how big a price gain is in prospect, column [E], and how likely is today’s RI forecast to produce a profit [H] as a proportion of the [L] sample of such forecasts. That combination result appears in the [ I ] %payoff which includes loser forecasts as well as the INTC 56% [H] winners. The size of [ I ] relative to [E] is a measure of [E]’s credibility in [N].

Time required [J] to accomplish the payoff is another important dimension for any investment mission. The retirement, tuition, or health emergency clock won’t patiently wait for “long-term-trend” investments to be “sure” (like EK, GM, GE, others) of their “passive investment” buy&hold strategy results. Compound Annual Gain Rates [CAGR] are the essential measures [K]. Figure 3’s rows are ranked by the historical results (of today’s RI) statistic.

One additional complication of being time-efficient in an investment strategy is that the score-keeping can’t be easily sliced up into uniform time periods. That is not what happens to holdings in an active investment strategy. Gains (and losses) occur in irregular lumps of time, and we need to evaluate likely prospects in the way they may be accumulated.

What is done in proper financial analysis of any capital commitment is to anticipate the RATE of gain or cost in units of change per time of involvement. The most commonly used measure is basis points per day, where a basis point is 1/100th of a percent.

That’s a tiny unit, but is what works best. Put together and maintained each day for a year, 19 of them would double your investment. They can be powerful.

In Figure 1 we use the Odds of gain [H] as a weight for the average prior payoffs [ I ], and take the complement of [H] ( 100 – H ) as a weight for the risk prospect [F]. Put together as [O] + [P] in [Q] we have an odds-weighted net outcome of each row’s prior MM RI forecast sample [L]. Then by converting those [Q] nets into bp/day in [R] we have a guide to making investment selection decisions across a broader array of alternatives.

Using [R] as an integrated measure of wealth-building desirability places PATK in first place by a wide margin among most MM forecast-population stocks. Its 29 bp/day score is about even what the first-place candidates produce.

The limits of the Figure 1 tradeoff proposition deny trends of the MM forecasts for the subject securities involved. To probe that exploration further, we offer some history of what has been seen in the market movements of PATK, first daily during the past six months, Figure 2, and then weekly over the past two years, in Figure 3.

Past MM Forecast trends for PATK

Figure 2

Figure 3

The vertical lines in these pictures are not actual past market prices like those seen in “technical analysis charts”. Instead they are forecasts of likely future ranges of market stock prices implied as probable in coming weeks and near months. The heavy dot in each vertical is the market close price on the day of the forecast. It splits the forecast range into upside and downside price change prospects.

The imbalances between up and down potentials are what are useful in estimating both coming price direction and extent of change. Their proportions are measured by the Range Index [RI]. Its value is the percentage of the whole forecast range which lies below the current market quote. A 20 RI has 4 times as much upside prospect as down. A 33 RI has only 2 times as much upside potential as downside.

Segregating past MM implied forecasts by their RIs produces clues to how market prices have reacted to the conditions seen by the MM community at various points in time. We use a 5-year sliding window to count how many prior forecasts (the sample size) have been like the current Range Index.

A major part of PATK’s appeal comes from its high Win Odds from prior forecasts at the Range Index of 50. Winning all but 2 out if 41 prior forecasts made at today’s RI put its Realized Payoff average at +7.4%, far better than other most recent realized payoffs shown in Figure 1’s column [ I ]. But what makes these gains really competitive is the speed of market movements they involve, column [ J ]. For PATK a 23 market day holding is only about half that experienced in the “people also watch” group and the overall MM forecast population. Far better than in SPY, with nearly twice the capture.

The 20 best-odds ranked members of the forecast population make average gains of twice PATK’s but at nearly twice the length of time investment involved. That puts them on a close-to equal rate of capital gain in basis points per day.

Conclusion

Patrick Industries Inc. (PATK) offers a good near-term capital gain prospect at this timely price opportunity. In tax-sheltered accounts it represents a productive, odds-on interim use of capital from less-fortunate position holdings. It is a clear choice for the employment of new or to-be-reinvested capital.

Disclaimer:

We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So, our information presents for D-I-Y investor guidance what the arguably best-informed professional investors are thinking. Their insights, revealed through their own self-protective hedging actions, tell what they believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided in the SA blog of my name.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information, earlier helping professional investors and now individual investors, discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations

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