next for stocks

What’s Next for Stocks in 2017? Private equity knows

A significant portion of my time every day is spent reading.

I read company reports, academic studies, several newspapers and even industry journals to try and keep on top of what’s going on in markets and the world.

This year I find that I am doing a lot of listening as well as podcasts are all the rage, so I spend a lot of time listening to James Altucher, David Rubenstein, James Grant and several other podcasts. I usually listen while I am running my screens and tests every day and I have found them to be an excellent way to gain exposure to new ideas and ways of thinking.

What I need to get better at is picking up the phone and talking to people who work in finance private equity, politics, the press and other outlets that might provide some interesting information.

I think I am a pretty intelligent guy and I am highly confident in my ability to find stocks that are long-term winners, but I am also aware I am not the only smart guy on the planet. One of the things that has enabled me to experience a fair amount of success over the years is that I am constantly trying to learn. Talking to other smart folks is a good way to accomplish this so it’s something I am working on doing more often.

In fact, I find that I learn a lot more when I am the dumbest guy in the room. Fortunately for me, that is quite often the case!

I had a great conversation earlier this week with Dan Shea of investment bank BDO Capital Advisors. Dan is in the L.A. office of the firm and is the Managing Director and Head of Private Equity Coverage. He has decades of experience providing deal and valuation advice to both strategic and private equity buyers and sellers of companies and is on top of what’s going on in the private equity world today.

I study the private equity industry quite a bit as we tend to view stocks and valuation in a very similar fashion, so I was interested to hear what Dan had to say as we enter the second half of the year.

Dan told me that there is a hunger for quality deals right now. The political landscape has created a lot of uncertainty and buyers and sellers alike are a little hesitant. Private equity firms are out there looking for deals, but everyone wants a little more certainty on things like healthcare and tax reform. He is also seeing something of a shift to strategic buyers right now as one of the few ways for companies in more mature industries to grow at the moment is to acquire smaller firms that can add to revenues and cash flows.

We also discussed deal valuation levels. He said that while EBITDA multiples are high right now with deals getting done at close to a nine multiple, high has become something of a new normal for now. There are private equity buyers and strategic buyer competing for a relatively small pool of potential deals so if you see something you like you have to pay up for it right now. Dan pointed out that presents some challenges for buyers as paying a high multiple leaves little room for error if you are hoping to earn the traditional high returns private equity investors have come to expect.

As an aside average multiple don’t mean it is impossible to find quality deals at great prices. It just means it’s far more challenging.

Josh Harris of private equity leader Apollo Global Management (APO) spoke on the firm’s first quarter conference call earlier this year and attributed his firm’s success in recent years to being able to put deals together at an EBITDA multiple of 5 or 6 when everyone else was paying 9-10. That’s my thought as well, and I have learned to stay pretty inflexible on the multiples I am willing to pay when buying shares in a company.

In spite of political uncertainty and high multiples, Dan said deals are getting done. CEOs and private equity buyers are far more confident that they were this year. There is some uncertainty around tax and regulatory reforms timing, but most are confident that reform will happen under this administration with very positive results for business. We are also seeing a steady pool of new sellers enter the market as baby boomers near retirement and think about selling their businesses. Deal pipelines are filling up, and Dan thinks we will see a lot more activity in the second half of the year and into 2018.

When I asked him what sectors he thinks will see increased PE activity he mentioned two specifically. The first one was a bit of surprise, but Dan said that building products are seeing a lot of interest.

James Altucher and I spoke earlier this week, and he mentioned that new housing sales and existing housing sales are up, but housing starts are down. Eventually, there will be lack of supply in houses and housing will rebound huge. Apparently, PE firms are seeing the same trend and are looking to add these companies to their portfolio.

Dan also mentioned healthcare as a sector that will continue to attract a lot of attention. I have talked about healthcare as a source of ongoing growth, and several of our microcap stocks are in the healthcare field. The healthcare market is ever changing as new products and technologies are introduced every day so there should be a continual supply of new opportunities to evaluate as potential new investments in our portfolios.

When it comes to investing information is your most powerful tool. Along with reading and podcasts talking to smart people is a powerful tool to know more than you can learn on your own.

Tim Melvin

Written By Tim Melvin

As a 30-year veteran of the financial services and investment industry Tim Melvin served as a broker, advisor, and portfolio manager. He’s combined this nearly three decades of experience with a love of value investing in order to help investors worldwide to multiply profits and build their nest eggs. As an avid value investor, Tim...