Cruise ship company CCL (Carnival) released its Q1 results, sending the shares up 7.2% to 3241p. It reported:
We are experiencing an ongoing improvement in underlying fundamentals based on our successful initiatives to drive demand. Our efforts to further elevate our guest experience are clearly resonating with consumers and, notably, improving the frequency and retention of our loyal guests.
CCL had a Stockopedia Momentum rank in the 90’s until recently, where it has slipped to 87. It is possible that when they refresh their statistics, it will be in the 90’s again. It has a 6 month relative strength of 27%, which puts it at least in the top quintile. It has a Piotroski score of 8.
I bought CCL as a momentum recovery play back in January, and so far, it has been OK as a performer. Not spectacular, but nothing like the disasterous money I have poured down the drain on miners.
Back in June 2014, Greenblatt said that he was shorting CCL, because it wasn’t cheap, and was earning a low return on capital and investing even more money; the very opposite of a “good and cheap company”, in fact. Unfortunately, taking a short position at that point would have been a disaster. The shares were at 2200p at the end of June, and are now at 3241p.
This is, I believe, highlights a real problem with Magic Formula investing. Companies with high PEs and low returns on capital may (but not necessarily, of course) be at their nadir, and ripe for a recovery. Cyclical companies live in a topsy-turvy world. Cyclical companies tend to have low PEs and high ROEs at the peak of the cycle, and high PEs and low ROEs at the bottom of the cycle. Investors who buy cyclicals “because they are cheap” often end up regretting it. As Lynch said: buying cyclicals after several years of record earnings and are on low PEs is a proven method for losing half your money in short order. I think Greenblatt made a bit of a schoolboy error on his CCL short.
I had noticed that the operating margins for CCL were amongst their lowest. CCL’s Value Rank is 33, which does not on the face of it make it compellingly cheap. A combination of a mediocre value score and high momentum is exactly the kind of thing that a value investor wouldn’t likely touch. Value investors tend to be hard-wired to resist buying momentum.
However, I reasoned that CCL appears to be in recovery, so I could expect margins to improve. The recovery is based on both qualitative and quantitative aspects: the narrative that the company is pushing out, and the high Piotroski score of 8. The PE of 16 might then not appear to be so expensive as first supposed, especially as the PEG ratio is 0.52.
CCL also qualifies for Stockopedia’s Value Momentum screen. They describe it as “impatient value”, where the stocks have a high momentum and a low PEG. It is not a low PE “value”.
I actually think there’s a secret wisdom behind that strategy, and I would like to explore Momentum investing further in my Fantasy Fund.
I actually think a simple strategy of buying a stock whose Momentum score is in the 90’s and whose Piotroski score is at least 8, and then selling when the Momentum score dips below 80 would actually be quite a good strategy. Not foolproof, but quite good.
I could be speaking too soon about CCL, but their latest RNS certainly seems to point towards continuing recovery. Is the recovery fully priced in? We shall see, but the positive reaction to today’s announcement is encouraging.
Happy investing to you all.