Focusing on what’s knowable and important

After a very strong 2013 for stocks, the turbulent start to 2014 has everyone asking the same age old question: Where is the market going this year? Bulls claim the stock market still has legs to push higher, while bears exclaim that valuations have gone too far beyond earnings growth and we are due for correction. My take? I have no idea. I can only focus on what is important and knowable.

As some managers on the Covestor platform have moved to cash over the last few months, the Leveraged Value portfolio is still nearly 100% invested in equities. This doesn’t mean I’m certain equities won’t take a dip in the second half of 2014. It just means I know equities beat cash over the long-term. Investing builds wealth. Holding cash doesn’t. If Warren Buffett and Peter Lynch can’t time markets, then I probably can’t either.

So what is important and knowable? What’s important is being able to look at the individual businesses and know whether they have sustainable earnings that make them attractively priced.

After the market’s rise in 2013, finding bargains is proving to be a bit more difficult in the middle of 2014. Let’s highlight two stocks in the Leveraged Value strategy that I believe to have most compelling values in my opinion.

Syntel (SYNT) is an IT and business process outsourcing service company. I am bullish on the outsourcing sector in general because of the large cost advantages of moving white collar work overseas. Since 2009, Syntel has grown earnings at an average rate of 18% per year and currently trades just below (15 times) trailing earnings.

In my opinion, Syntel can be conservatively valued at 17 times trailing earnings, which would give it a value of $93.84 (14% increase). I don’t necessarily see home run potential from Syntel, but my confidence in a small gain is reflected in it being the largest holding in the portfolio.

TransGlobe Energy (TGA) is a Canadian oil and gas exploration and development company that primarily operates in Egypt. Due to the political turmoil in Egypt, TGA has been a rollercoaster stock. In my opinion, this political risk is overblown and the market’s misunderstanding has potentially offered upside in TGA.

Accounts receivables peaked in the 3Q of 2013 as management reported the company came away fairly unscathed from the turmoil. When we think of Egypt, we picture the news footage of riots in Cairo so it is natural to think that TGA would be affected. However, a more in depth look at the operations of TGA reveal something different (see below).

So we can see that the protests in Cairo are happening about 300 km from TGA’s land in South Alamein, which is about the same distance from Detroit to Columbus. Now I’m not trying to say that political risks for TGA are non-existent. I’m simply trying to illustrate the point that we can’t always make blanket assumptions for an entire country and assume that all parties will be equally affected.

With that being said, management has said their biggest issue in 2014 has been mechanical failures which will be replaced in the 4Q of 2014. Finally, the 2 analysts who cover the stock give an average estimate of $1.42 EPS in 2015, putting the price of the stock at just 4.77 times 2015 earnings.

DISCLAIMER: The investments discussed are held in client accounts as of May 31, 2013. These investments may or may not be currently held in client accounts. International investing involves special risks, such as political instability and currency fluctuations. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

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