Best Stock Selection Requires Clear Comparisons

Readers familiar with our work may want to skip to the Comparing Details heading below.

This article rewards investors who choose to direct their investments of TIME and capital to those alternatives with the highest likelihood of successful rates of return among ones compared under identical important measures. Brooks Automation, Inc. (BRKS) provides attractive answers to these questions:

  • What alternative choices are available?
  • Which have the best trade-offs between forecastable reward and risk?
  • How big a reward is realistic to expect? Why?
  • How often may disappointment occur?
  • How much time and capital may disappointment involve?
  • How frequently may the rewards expected be compounded?

These are questions often neither asked nor answered by many investment analysis reports. The commonplace approach is to present those aspects of one investment which may set it apart from others, but fail to make the essential decision-supporting step of comparing alternatives on an equal-measure basis.

If your thoughts about comparative values lead to P/E ratios, do you really believe in “generally acceptable accounting practices”?

Do you really believe that multi-year, competitive share-of-market forecasts can be made in today’s rapidly advancing technology environment without error provisions – provisions carried forward into the G of PEG value assertions?

Instead, look to demonstrated human-nature behavior of self-protection. “When the oxygen masks come down, be sure to put yours in place before attempting to help others”.

That is the perpetual work environment of investing market-makers [MMs] whose role is to aid buyers and sellers find a point of price balance right now in multi-million-dollar block trades. A balance which usually requires them to put a part of their own firm’s capital temporarily at the risk of changing market attitudes and prices.

They won’t do it without the oxygen of price-change protection. That insurance comes from separate hedging deals in derivative securities where the operating leverage of the limited-life legal contracts involved makes deals practical.

What must be paid for the protection, and the way it is provided tells just how far those (sufficiently) in the know realistically expect prices may go. They all have real-money bets being made. Price range forecasts over time periods defined by the derivatives contract lives are involved.

Such forecasts are constantly being refined every moment investment markets are operating, and are made part of every market-day’s closing records. They provide an historical record (in subsequent market price actions) of how well the “smart money” can make useful forecasts – for specific stocks, ETFs, and indexes.

To get answers, we look to the best-informed market participants – the market-makers [MMs]. These are the dozen to two dozen firms providing price quotations to exchanges and transaction systems as a result of their extensive 24×7 worldwide information collection systems and evaluation resources. It is a community of perhaps 100,000 employees. The largest, Goldman Sachs, employs over 35,000 full-time.

Present-day markets are driven by major investing organizations commanding multi-billion dollar portfolios with stock contents which can only be adjusted by negotiated volume (block) trades between peers, not by “open auction”. Such trades set and move posted prices.

The individual investor typically is merely along for the ride. He/she needs to have a sense of where the negotiators are likely to head, pricewise. Conventional analysis often provides superficial descriptions and little linkage between operating minutia and price forecasts. As examples, here is how Yahoo Finance reports on BRKS:

Description

Brooks Automation, Inc. provides automation and cryogenic solutions for various markets. The company operates in two segments, Brooks Semiconductor Solutions Group and Brooks Life Science Systems.

The Brooks Semiconductor Solutions Group segment offers mission-critical wafer automation and contamination controls solutions and services. Its products include atmospheric and vacuum robots, robotic modules, and tool automation systems that offer precision handling and clean wafer environments; and automated cleaning and inspection systems for wafer carriers, reticle pod cleaners, and stockers. This segment also offers repair, diagnostic, and installation services, as well as spare parts and productivity enhancement upgrade services.

The Brooks Life Science Systems segment provides automated cold storage systems; consumables, including various formats of racks, tubes, caps, plates, and foils; and instruments used for labeling, bar coding, capping, de-capping, auditing, sealing, peeling, and piercing tubes and plates. It also provides sample management services, such as on-site and off-site sample storage, cold chain logistics, sample transport and collection relocation, bio-processing solutions, disaster recovery, and business continuity, as well as project management and consulting. In addition, this segment offers sample intelligence software solutions and customer technology integration; laboratory work flow scheduling for life science tools and instrument work cells, sample inventory and logistics, environmental and temperature monitoring, and clinical trial and consent management, as well as planning, data management, virtualization, and visualization services; and gene sequencing analysis and synthesis services.

The company serves the semiconductor capital equipment and life sciences sample management markets in approximately 50 countries. Brooks Automation, Inc. was founded in 1978 and is headquartered in Chelmsford, Massachusetts.

Figure 1

Wait a bit! This comparison is coming from market-makers [MMs]? On a stock with market capitalization of only $2 billion or so (column [T]), while most of SA’s readership interest is on $100-billion issues. What interest could MMs have in such dogs?

Take another look at column [U], the proportion of this stock now held by institutions: how can it be over 100%? The institutions are constantly looking at opportunities to build portfolio wealth, and evidently they don’t overlook small-caps, even buying shares sold short. But their everyday market volumes tend to be small, so it takes MMs to negotiate the block trades needed to make a difference in institutional-size billion dollar portfolios.

And apparently what BRKS has been producing for the semiconductor producer industry has parallel uses in the life sciences trades. Another strong, growing demand.

Our interest is perked when a small-cap is priced at a Range Index point which has previously produced big, prompt, reliable capital gain payoffs, competitive with the best of the larger (2,600+ stocks) MM forecast population.

Which is where BRKS is now. So read on.

Comparing Details

The essence of valuation is in comparison, which requires that the compared measures be as close to identical as possible. To that end, we place all of our valuations in a carefully defined set of measures, and describe them in as parallel set of comparisons as is possible.

What is important to us in this analysis is how big a price gain is in prospect, column [E], and how likely is today’s RI forecast to produce a profit [H] as a proportion of the [L] sample of such forecasts. That combination result appears in the [ I ] %payoff which includes loser forecasts as well as the BRKS 87% [H] winners. The size of [I] relative to [E] is a measure of [E]’s credibility in [N]. Perhaps the Life Sciences market protects BRKS from some of the semiconductor industry product price volatility.

Time required [J] to accomplish the payoff is another important dimension for any investment mission. The retirement, tuition, or health emergency clock won’t patiently wait for “long-term trend” investments to be “sure” (like EK, GM, GE, others) of their “passive investment” buy & hold strategy results. Compound Annual Gain Rates [CAGR] are the essential measures [K]. Figure 3’s rows are ranked by the historical results (of today’s RI) statistic.

One additional complication of being time-efficient in an investment strategy is that the score-keeping can’t be easily sliced up into uniform time periods. That is not what happens to holdings in an active investment strategy. Gains (and losses) occur in irregular lumps of time, and we need to evaluate likely prospects in the way they may be accumulated.

What is done in proper financial analysis of any capital commitment is to anticipate the RATE of gain or cost in units of change per time of involvement. The most commonly used measure is basis points per day, where a basis point is 1/100th of a percent.

That’s a tiny unit, but is what works best. Put together and maintained each day for a year, 19 of them would double your investment. They can be powerful.

In Figure 1, we use the Odds of gain [H] as a weight for the average prior payoffs [ I ], and take the complement of [H] (100 – H) as a weight for the risk prospect [F]. Put together as [O] + [P] in [Q], we have an odds-weighted net outcome of each row’s prior MM RI forecast sample [L]. Then by converting those [Q] nets into bp/day in [R], we have a guide to making investment selection decisions across a broader array of alternatives.

Using [R] as an integrated measure of wealth-building desirability places BRKS in first place by a wide margin among most MM forecast-population stocks. Its 30.9 bp/day score is about even what the first-place candidates produce.

The limits of the Figure 1 tradeoff proposition deny trends of the MM forecasts for the subject securities involved. To probe that exploration further, we offer some history of what has been seen in the market movements of BRKS, first daily during the past six months, Figure 2, and then weekly over the past two years, in Figure 3.

Past MM Forecast trends for BRKS

Figure 2

Figure 3

The vertical lines in these pictures are not actual past market prices like those seen in “technical analysis charts”. Instead, they are forecasts of likely future ranges of market stock prices implied as probable in coming weeks and near months. The heavy dot in each vertical is the market close price on the day of the forecast. It splits the forecast range into upside and downside price change prospects.

The imbalances between up and down potentials are what are useful in estimating both coming price direction and extent of change. Their proportions are measured by the Range Index [RI]. Its value is the percentage of the whole forecast range which lies below the current market quote. A 20 RI has 4 times as much upside prospect as down. A 33 RI has only 2 times as much upside potential as downside.

Segregating past MM implied forecasts by their RIs produces clues to how market prices have reacted to the conditions seen by the MM community at various points in time. We use a 5-year sliding window to count how many prior forecasts (the sample size) have been like the current Range Index. The recent price pullback for IR reduces its IR to 10.

A major part of BRKS’s appeal comes from its high Win Odds from prior forecasts at the Range Index of 50. Winning 7 out of every 8 prior forecasts made at today’s RI put its Realized Payoff average at +13.3%, far better than other most recent realized payoffs shown in Figure 1’s column [I]. But what makes these gains really competitive is the speed of market movements they involve, column [J]. For BRKS, a 34 market day holding is far less than that experienced in the “market proxy” ETF of SPDR S&P 500 Index (SPY) and the overall MM forecast population.

The 20 best-odds ranked members of the forecast population make average gains as good as BRKS’s but at a longer time investment. That puts them on an almost-equal rate of capital gain in basis points per day.

Conclusion

Brooks Automation, Inc. offers a good near-term capital gain prospect at this timely price opportunity. In tax-sheltered accounts, it represents a productive, odds-on interim use of capital from less-fortunate position holdings. It is a clear choice for the employment of new or to-be-reinvested capital.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BRKS over 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.

Additional disclosure:
Disclaimer: Peter Way and generations of the Way Family are long-term providers of perspective information, earlier helping professional investors and now individual investors, discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations.

We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So, our information presents for D-I-Y investor guidance what the arguably best-informed professional investors are thinking. Their insights, revealed through their own self-protective hedging actions, tell what they believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided in the SA blog of my name.

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2019-10-20