Profits and Catalysts
02/08/2016 10:00 am EST
Hedge fund industry veteran Linda McDonough has joined with Investing Daily to launch a new advisory service—Profit Catalyst Alert—focused on isolating stocks where underappreciated or unrecognized company and industry developments are set to drive the price higher.
Steven Halpern: I’m very excited today to be able to introduce our audience to Linda McDonough, editor of the newly launched newsletter Profit Catalyst Alert. How are you doing today, Linda?
Linda McDonough: I’m doing great. Thanks, Steve.
Steven Halpern: Well, your investment service’s new, but your strategy has been honed over many years as a hedge fund analyst. Could you tell our readers a bit about your background and the decision to launch a financial newsletter product?
Linda McDonough: Sure. Let’s see, I’ve been an analyst for various hedge funds researching stock for the last 26 years, primarily in the US, US equities both on the long and the short side.
Over time, I have noticed a pattern that when there is a new news event—a catalyst if you will—that will change the dynamics of the earnings for the company going forward, it typically is a pretty good buying point. I’ve learned that over the years.
I wrote a little bit for Real Money and I’ve always enjoyed boiling down the complicated process of stock analysis into relatable terms.
I was fortunate enough to cross paths with the people at Investing Daily recently and so we started talking and we began working on this newsletter probably last summer. Then we just launched it the first week of January.
Steven Halpern: As the name suggests, catalysts are a central role here and these are catalysts that you believe could drive the stock higher in price. Could you explain what some of the types of catalysts are that you look for and perhaps highlight some that you found to be most effective, historically?
Linda McDonough: Sure. The catalysts range from anything from a company launching a new product. Sometimes it’s a new customer, maybe a new distribution channel that they have. Often times, it’s an acquisition where they might buy a competitor and sort of take them out of the market.
Other times, it could be acquiring somebody who has a new customer, or they’re selling into a different industry, and it gives them access to that industry and other times it’s simply within the company—them developing something new that is perhaps a higher margin—or they’re getting better pricing for something.
These catalysts are all very unique to the particular company. There’s not really one that works for all of them. Once they sort of know about the catalysts, then I go through and analyze the numbers for that certain stock to make sure I can make an investment case for it going forward.
Steven Halpern: Turning to that analysis, within your proprietary stock picking system, you focus on small- to mid-cap stocks that offer what you would consider compelling value. What factors do you consider most important when looking for this value?|pagebreak|
Linda McDonough: Sure. Well, I have a pretty hard and fast rule that the companies need to be making money. This is not just momentum investing where there’s something new and the stock keeps going higher and higher on these companies.
They need to be earning money, and typically, I look for a price to earnings ratio that is less than the expected growth rate on earnings.
I also go through the balance sheet. I want to make sure that these companies don’t have too much debt, that they have really solid finances going forward.
Steven Halpern: Now you also go beyond just the paperwork involved in analyzing a company and take what you call a boots on the ground approach. Could you explain what that involves?
Linda McDonough: Sure. It’s anything as simple as calling the customers of the company, talking to other people within the industry.
Often times I’ll talk to competitors or hear what their take on a situation is and many times, almost all the time, I try to check in with the company and hear their side of the story, make sure I’m interpreting things correctly and just hear their view of the future.
Steven Halpern: To help our listeners better understand this investment strategy, let’s walk through a couple of ideas. First, you’ve recently recommended Vera Bradley (VRA), which is a women’s designer firm. What makes that an attractive play?
Linda McDonough: Vera Bradley makes, well, they’re historically known as making these fabric floral handbags which were really very, very successful for a long period of time and then they ran into some trouble in 2014, 2015.
They had really over distributed the product. There was too much out there. They kept coming out with new patterns too frequently so the consumers were not really that interested and so they really retrenched.
They shrunk the distribution system so that there aren’t too many bags all over the place and they’ve introduced some new products, single-colored, quilted, sophisticated bags.
They are a higher price point. They have much better sell through so they’re able to have better full price sell through and this has helped their profitability significantly. That’s a stock where the catalyst was really a reworking of an old product and the numbers are moving higher due to that.
Steven Halpern: Now, Very Bradley’s products are pretty easy for our listeners to understand, but at the other end of the spectrum you’re also recommending a company called Photronics (PLAB). Could you try—in layman’s terms—to explain to our listeners what this company does and what you find so attractive here?
Linda McDonough: Sure. Photronics makes what they call photo masks and photo masks are a tool that are used to produce very small and sophisticated computer chips.
What has helped the catalyst on Photronics is that some of their customers have been requesting more and more sophisticated photo masks so these masks again are a higher price point.
They are a better improved profitability for Photronics, and as the chips are getting smaller and smaller and more complicated, the percentage of Photronics business where they are selling these higher priced, higher margin masks has increased.
Steven Halpern: Again, our guest is Linda McDonough. Congratulations on the launch of Profit Catalyst Alert and thank you so much for your time today.
Linda McDonough: You’re welcome. Thanks, Steve.