Omega Healthcare Investors: 'You Won The Month'

Image via Twitter.Some of the money you lost holding OHI since July. Image via Twitter

“Hey, Professor!” Charles turns around to see a very short, very wide man stamping and scraping his feet on the cinders. His blunt, wide head is lowered beneath his mountainous shoulders, and a massive nose ring loops between his snorting nostrils. “Who are you? asks Charles. “I’m a real angel,” says the man. “Then where are your wings?” “Don’t be stupid! That’s just a cliche.” Even before these words are out of his mouth, the man has begun running toward Charles, ramming his blunt forehead into Charles’s solar plexus and knocking him onto his bewinged back. It is a moment before Charles can catch his breath. He sits up and asks, “What did you do that for?” “To teach you a lesson.” “What kind of lesson is that?” “What other kind of lesson is there?”

– Stephen O’Connor, “Here Comes Another Lesson”

Man must suffer to be wise.

– Aeschylus, “Agamemnon”

“You Won The Month”

That was one of the dismissive comments we received on our recent article pointing out that our top names from early October had outperformed Omega Healthcare Investors (OHI) by 20% since we wrote that OHI was still not healthy enough for us last month. Here we respond to that and a few other points brought up by readers.

This Isn’t Hindsight; It’s Foresight

The top-rated comment on our OHI article on Thursday suggested we had conducted an exercise in hindsight (“It’s too bad none of us have the luxury of retrospective investing”):

Image via SA.

This wasn’t hindsight though: we wrote about our system rejecting OHI before its drop, and we had shared our top names with our Bulletproof Investing subscribers the day before.

We Didn’t Just Win The Month

Here’s a simple way to demonstrate that our top names beating OHI since early October wasn’t a fluke. We also wrote an article in early July saying OHI was not healthy enough for one of our portfolios. That article was published on Monday, July 10th, using data as of Friday, July 7th. We shared our top names as of July 7th in this Marketplace post at the time. They were: Align Technology (ALGN), Activision Blizzard (ATVI), ServiceNow (NOW), Brinks Company (BCO), IPG Photonics (IPGP), HDFC Bank (HDB), CSX (CSX), ILG (ILG), Regeneron (REGN), and Bob Evans (BOBE).

Here’s how they have done since July 7th:

Chart via YChartsHere’s how OHI has done since July 7th:

Chart via YChartsCongratulations, OHI longs: you outperformed the worst of our top names from July 7th, Regeneron, which is down 20.5% since. But, on average, our top 10 names from July 7th are up 16.4%, while OHI is down 13.1%. So our top names have outperformed OHI by 29.5% since July 7th.

We Don’t Own Our Top Names Or Hedged Portfolios

That’s correct. We don’t own them because we have been reinvesting all of our free cash in the Portfolio Armor system that generates them. Our software development, financial data, and other costs are considerable. At some point, we expect our revenues to outstrip our costs, and at that point, we’ll be thrilled to invest in our hedged portfolios. We certainly won’t be buying falling knife REITs.

“Do It Again”

A few commenters asked us to repeat the trick a third time, to give you our analysis of OHI as of now and our top names that we expect will, on average, outperform it over the next several months. Our current analysis of OHI is the same as it was in early October: it fails our first screen and so would not be included in any portfolios generated by our system. Below is a screen capture from our site’s admin panel illustrating this.

Image via Portfolio ArmorThe “Long Term Return” there represents OHI’s total return (including dividends) over the average 6-month period over the last ten years. The “Short Term Return” is OHI’s total return over the most recent 6-month period. Our first screen is that the mean of these two figures, labeled “6m Exp Return” above, must be positive. As you can see above, it’s not. Because OHI fails our first screen it’s excluded from consideration in any of our portfolios now.

Essentially, our system assumes that security returns will begin a process of mean reversion over the next several months. If the mean of the short and long term returns is positive, it then applies a second screen as a “sanity check” on whether mean reversion is too optimistic a scenario in the case of a particular security.

If you’re curious what our second screen is, it’s a gauge of option sentiment. Since OHI fails our first screen now, we don’t apply it here, but we did apply it to OHI in our July article, since OHI passed our first screen then. OHI passed our second screen as well in July, but it failed our third test for inclusion in one of our portfolios, as its hedging cost exceeded its our potential return estimate for it. Hence we described it as “not healthy enough” for us in July.

As for our top names as of now, we posted them here for our Marketplace subscribers Thursday night.

Our Top Stocks Don’t Have High Dividend Yields

This may have been the second-most liked comment, despite us conceding the point in our article:

Here again, we’d ask readers to think in terms of total returns, which include income as well as capital gains, instead of income alone. You can create your own income stream by selling shares if you have capital gains. Thinking about income alone is dangerous for two reasons. The first is that you may end up with negative total returns if your stocks drop significantly. The second reason is that extended share price declines are often due to issues that may lead to dividend cuts in the future. A recent example of that, one mentioned in the comments of our previous OHI article, is General Electric (GE), which just halved its dividend.

We Make Mistakes Too

Another commenter asked us to turn our criticism inward:

We’ve made plenty of investing mistakes. Here are a few that come to mind:

  • Buying 3Com instead of Cisco (CSCO) in the late 1990s because 3Com looked cheaper according to common valuation metrics.
  • Selling Priceline (PCLN) in the teens after buying it in the 80s after its IPO. Our 200 shares would be worth nearly $350,000 today. And we may have had more than 200 shares.
  • Buying dogs like New Frontier Media (NOOF) because they appeared on Joel Greenblatt’s backward-looking “Magic Formula” screener.
  • Buying other “Magic Formula” dogs, e.g., Heely’s (HLYS).

It was those mistakes that led us to develop a better approach to portfolio construction, one that seemed counterintuitive to us at first as well.

Our security selection method still makes mistakes, such as picking Regeneron in July. But since every position in one of our portfolios is hedged, an investor’s downside risk is strictly limited. You can see an example of this here, where we describe how one of our hedged portfolios generated a positive return despite holding another stock that turned out to be a bad pick, Sinclair Broadcasting (SBGI).

Everyone Makes Mistakes

Everyone makes mistakes. How we grow is by acknowledging them and learning from them. If you are open to a different approach to investing, one that enables you to strictly limit your risk while maximizing your potential return, we invite you to read our recent article on how much risk you need to take to have a chance at market-beating returns.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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