Finding Undervalued Gems in an All Time High Market

Key Concepts

Market Valuation: The assessment of a stock or market's current price relative to its intrinsic value.
Price-to-Earnings (PE) Ratio: A valuation metric that compares a company's stock price to its earnings per share.
Intrinsic Value: The perceived or calculated true value of a company or asset, independent of its market price.
Bottom-Up Approach: An investment strategy that focuses on analyzing individual companies rather than the overall market.
Overvalued, Fairly Valued, Undervalued: Categories used to classify stocks based on their current market price relative to their intrinsic value.
Economic Moat: A sustainable competitive advantage that protects a company's long-term profits and market share from competitors.
Oracle IQ: A proprietary ranking system used by Stock Oracle to assess stocks based on predictability, profitability, growth, economic moat, financial strength, and valuation.
Bear Trap Pattern: A technical analysis pattern where a stock price falls sharply, triggering stop-loss orders, only to reverse and move higher, trapping short-sellers.
Stock Oracle: A software tool used for fundamental and technical analysis of stocks.

Market Valuation and Identifying Undervalued Gems

The video addresses the common media narrative that US markets are overvalued and poised for a crash when they reach all-time highs. The speaker argues that this perspective is often based on a superficial analysis of metrics like the Price-to-Earnings (PE) ratio. While the forward PE ratio of the S&P 500 at 22.1 times earnings is indeed above its 5-year (19.9) and 10-year (18.4) historical averages, this metric alone is insufficient.

Critiquing Macro Valuation Metrics

The speaker emphasizes that PE ratios are meaningless without considering earnings growth rates. Companies today grow faster and have significantly higher profit margins (double to triple) compared to 20-30 years ago, justifying higher PE multiples.

The Importance of a Bottom-Up Approach

Instead of a top-down macro view, the speaker advocates for a bottom-up approach, akin to assessing individual wealth within a country rather than relying solely on GDP per capita. This involves analyzing individual companies to identify those that are truly overvalued, fairly valued, or undervalued.

S&P 500 Valuation Breakdown

A detailed analysis of the S&P 500 companies, conducted by the speaker's research team, reveals the following distribution:

Very Expensive (Over 20% above intrinsic value): Approximately 160 companies (31.9% of the S&P 500). These are considered bubble territory and are not recommended for purchase.
Overvalued (10% to 20% above intrinsic value): 13% of companies (65 stocks). These are placed on a watchlist, to be considered for purchase when they become fairly priced or undervalued.
Fairly Valued (Within +/- 10% of intrinsic value): 157 companies (31% of the index). These are candidates for closer examination.
Undervalued (10% to 20% below intrinsic value): 46 companies.
Highly Undervalued (More than 20% below intrinsic value): 73 companies (23.8% of the index). This segment represents the "undervalued gems" the speaker seeks.

Examples of Valuations

The video provides examples of stocks in different valuation categories (as of yesterday's data):

Highly Overvalued: Costco, IDEX, Texas Instruments, Tyler Technologies, Intuitive Surgical, Exxon, Netflix, Tesla, ICE, Coin.
Overvalued: Apple, Nvidia, Blackstone, Union Pacific, IBM, Mastercard, McDonald's, Moody's.
Fairly Priced: Abbott Laboratories, Intel, Pepsi, Proctor & Gamble, Win.
Undervalued/Highly Undervalued: Specific tickers are not read out but are visible on screen.

The "Cheap Crap is Still Crap" Principle and Stock Oracle

A crucial point is made: "don't buy a stock just because it is cheap because cheap crap is still crap." The focus must be on buying high-quality stocks that are undervalued. To facilitate this, the speaker introduces Stock Oracle, a publicly available software tool that simplifies the analysis process, which previously involved extensive manual research of financial statements, 10-Ks, 10-Qs, and transcripts.

Case Study 1: PayPal (PYPL) - Undervalued but Lacking a Strong Moat

The speaker uses PayPal as an example of an undervalued stock.

Valuation: Oracle Value of $84, current price $69, indicating undervaluation. The stock has fallen significantly from over $300.
Growth Projections: 11% for the next 3-5 years, 9.5% long-term.
Profitability & Financial Strength: Return on Invested Capital (ROIC) of 14.84%, Return on Equity (ROE) of 22%.
Oracle IQ Ranking: High in predictability, medium in profitability and growth, narrow economic moat, high financial strength, and undervalued.
Financials: Historically consistent revenue, slightly inconsistent but uptrending net income and free cash flow. Shares outstanding are decreasing (buybacks). Gross profit margins are falling, but operating and net profit margins are consistent. ROE and ROIC are high and consistent.
Intrinsic Value Calculations: Various valuation methods (DCF, P/S, P/E) suggest a significantly higher intrinsic value than the current price.

Reason for Not Investing in PayPal: Despite being undervalued and having strong financial metrics, PayPal's economic moat score is only 4 out of 10. This indicates a weak competitive advantage, making it susceptible to disruption from competitors like Visa, Mastercard, Google Pay, and Apple Pay. The speaker requires a moat score of at least 6 out of 10 for long-term investments.

Moat Analysis Breakdown:
- Brand Loyalty & Pricing Power: 5/10
- Barriers to Entry: 3/10
- Switching Costs: 2/10
- Network Effect: 4/10
- Economies of Scale: 4/10

Case Study 2: Copart (CPRT) - Undervalued with a Strong Moat

Copart is presented as an example of a high-quality, undervalued stock.

Valuation: Intrinsic value of $57, current price $48, indicating undervaluation. The stock has experienced a recent dip but is on a strong long-term uptrend.
Growth Projections: 10% for the next 3-5 years, 10.4% long-term.
Profitability & Financial Strength: ROE of 18.54% (excellent), ROIC of 18.34% (excellent).
Financials: Consistently growing revenue, net income, and free cash flow. Shares outstanding are increasing (early growth stage). The company has substantial cash and no debt, indicating a solid balance sheet. Margins have been falling slightly, but net profit margins are consistent. ROE has been falling but is still above 15%, attributed to rising equity due to retained capital.
Oracle IQ Ranking: High in predictability, medium in profitability and growth, wide economic moat, high financial strength, and undervalued.

Reason for Investing in Copart: Copart possesses a strong economic moat score of 8 out of 10.

Moat Analysis Breakdown:
- Brand Loyalty & Pricing Power: 5/10
- Barriers to Entry: 9/10
- Switching Costs: 7/10
- Network Effect: 9/10
- Economies of Scale: 9/10

The speaker highlights Copart's business as the leading provider of online vehicle auction and remarketing services, with a strong position due to its extensive network, proprietary technologies, and efficient operations.

Technical Analysis of Copart

The speaker also incorporates technical analysis:

Long-Term Chart: Shows a strong uptrend and a significant support area.
Recent Price Action: The stock is bouncing off the 150-day moving average on weekly candles.
Double Bottom Pattern: A classic bullish reversal pattern observed on the chart, indicating a potential bear trap where retail traders' stop losses are triggered before the price reverses upwards.

Based on strong fundamentals, undervaluation, a robust economic moat, and a bullish technical pattern, the speaker has been actively accumulating Copart shares weekly.

Conclusion and Actionable Insights

The video demonstrates a systematic approach to identifying undervalued investment opportunities in a seemingly expensive market. The key takeaways are:

Look beyond headline valuation metrics: PE ratios alone are insufficient.
Adopt a bottom-up approach: Analyze individual companies.
Prioritize quality: Focus on high-quality businesses, not just cheap stocks.
Assess the economic moat: A strong competitive advantage is crucial for long-term success.
Utilize analytical tools: Software like Stock Oracle can streamline the research process.
Combine fundamental and technical analysis: Use both to make informed decisions.

The speaker encourages viewers to explore Stock Oracle for their own analysis and to subscribe to the channel for more investment insights.