Scanning For New Opportunities

10/03/2013 6:00 am EST

Focus: STOCKS

Michael Khouw

Partner, The Options Edge

DASH Financial's Michael Khouw discusses some of the methods that he uses to find new opportunities and what role the activity of some headline investors plays in his strategy.

SPEAKER:  Hello and thanks for joining us.  My guest today is Mike Khow.  Hi Mike, and thanks for being here. 

MICHAEL KHOW:  Oh, thanks for having me. 

SPEAKER:  Sure.  Well, I've seen you on CNBC talking about different options and things that you've done, but your background is much greater than just options, so tell me a little bit about your strategy and how you actually find investments. 

MICHAEL KHOW:  So my background is basically as a fundamental investor, so at the core of it basically what I typically do is I will screen for opportunities that look good on a fundamental basis.  What I mean by looking good on a fundamental basis is we try to look for drivers for a particular industry, so for as an example in a specific industry there's probably going to be something that drives it and we're going to try to look at that.  Then we want to look at conventional metrics.  This industry, what is the normal price to earnings ratio, how does that look compared to its conventional metrics, how does it compare to the market, and then growth opportunities, and then of course the broader macro economic picture.  So the broader economy conventionally is going to most cyclical businesses with it, so we're going to look at that.  We're going to look at the multiples.  We're going to look at their growth opportunities and then we're going to compare it to other securities and to the broad market.  

SPEAKER:  So you're really more of a top down type of analyst, or do you do some bottom up also where you say hey, I heard something's going on over here, let's take a look at this. 

MICHAEL KHOW:  It's hard not to start taking a look at special situations when they arise, and a good example of that are going to be deal stocks, so is when there's a merger going on, in fact we've had a lot of news about airline mergers for example. 

SPEAKER:  Sure. 

MICHAEL KHOW:  When you look at these companies, one of the things you want to do is in those kinds of catalyst driven situations it's very easy for there to be mispricing, and we certainly do look at those situations as well.  That's a little bit harder though I think for some people to do unless they're really willing to dig in and figure out what propels an industry and how to figure out what the valuation is because you're often dealing with deal term sheets and things like that, but I will tell you this, if you read all of the documentation that's publically available, a lot of things often stick out and you will find things that are frequently very mispriced.  We saw that in some of the airlines, stocks were mispriced by maybe 50%. 

SPEAKER:  That's huge. 

MICHAEL KHOW:  And when you see a mispricing of 50%, it's hard not to want to take advantage of it, and so in many cases that's what we'll do. 

SPEAKER:  Now, would you also look at the situation like Carl Icon buying into Apple, then George Sores saying that he has a position in Apple.  You would say oh, well, is that, I'm past due now, I'm past the point where I could make any money on it, or do you think that that would be a catalyst that the average investor could go, well maybe I should look into that a little bit further? 

MICHAEL KHOW:  Well, I think when you see particularly savvy investors beginning to participate in something, you might want to ask yourself why.  Now, in our particular case because we were at a big hedge fund, conventionally we would be doing the same thing that Carl would be doing. 

SPEAKER:  Sure. 

MICHAEL KHOW:  Hopefully we would do it as well. 

SPEAKER:  Yes. 

MICHAEL KHOW:  And actually he's probably about as good as it gets. 

SPEAKER:  Yes. 

MICHAEL KHOW:  So I would like to think we were doing the same process, so it's not uncommon for us to find ourselves in positions that other investors are in.  Carl Icon looks for stocks that are exceptionally cheap, and the most recent incidence, Apple was a good example, but there are many that have preceded.  The Herbalife story that came out and there's a very public spat going on -

SPEAKER:  Yes. 

MICHAEL KHOW:  - between Icon and Ackerman.  Herbalife, if you looked just at the fundamentals was a very, very cheap stock so if you didn't agree with Ackerman's thesis, you had to believe that fundamental investors such as Carl, such as Dan Lobe and some of the other guys that piled in, were likely to do that.  That was an example.  CVR Energy which is a mid continent refiner a couple years ago, exact same situation.  You have companies that are trading about four times free cash flow, you know, or single digit earnings multiples and they're also still growing.  When you see that kind of thing, there's often some reason why they're trading cheap but if you get over that hurdle, if you can say, you know what?  I'm not as concerned about that as the broad market seems to be, you can find some real values. 

SPEAKER:  Tremendous.  Thank you so much. 

MICHAEL KHOW:  Sure, it's my pleasure. 

SPEAKER:  And thanks for being with us at the MoneyShow.com video network.

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