A smart investor doesn’t really try to track the entire market to find new investments to make. Given the thousands of publicly traded companies on U.S. stock exchanges alone (around 5,000 on the NYSE or NASDAQ exchanges), it really isn’t very practical to think that any individual is going to be able to track them all. Instead, the most successful investors I’ve known over the years keep track of just a handful of stocks at any given time. Over the years, I’ve worked with lists as small as a couple of dozen and upwards of 100 stocks at any given time, but have never really expanded my active list (the ones that I actually check every day) beyond a dozen or so. That’s been true for me through two recessions and three bull markets, and it’s applied to my use of investing strategies that included short-term methods like swing and trend trading and longer-term philosophies like value investing.
Working with smaller lists makes the process of tracking the market more efficient and manageable, especially if like most people, investing is just a single part of your busy lifestyle. Few people have the time to spend all day, every day watching the market from open to close, combing through one earnings report after another. The truth is that you don’t have to; if you can put together a smaller, functional basket of stocks to work with, you’ll usually find it’s more than sufficient to keep you busy while still giving you plenty of opportunities to work with.
As a value investor, my active list stays pretty fluid. I prefer to focus my attention from one day to the next on the stocks that I know are working at valuation levels that I know I can work with. But since an undervalued stock today will hopefully not be undervalued in the future, I often move stocks out of my active list once I close a profitable position on them or they move out of a trading range I think gives me a good value opportunity. I don’t stop watching those stocks, but my check on them becomes more sporadic. That is also true when I see a stock extending an upward trend that I don’t already have an open position in. If it’s moved beyond the point that I think represents a good value, I simply put into a secondary list, which means I’ll come back to it at some point in the future.
The interesting thing about some of those stocks is that sometimes I’ll decide to take a look at a stock I’ve used in the past at lower prices, and I’ll find that while the stock may be much higher now than it was when I invested in it previously, some of its other fundamental information – like Book Value, for instance, may have also improved significantly. In fact, they may have improved enough that the stock’s latest high price still represents a nice value. That’s an interesting wrinkle in the game for a value-oriented investor like me, because it helps to keep my active list fresh with companies I’m already familiar with, but that haven’t been a daily part of my market check for a while. It’s like coming back to an old friend to get reacquainted.
This morning I circled back to one of those old friends. Eastman Chemical Company (EMN) is a stock I first used in late 2016 when it was trading around $65 per share. As of this writing the stock is above $101; its rise began around the same time I started paying attention to it, and after I closed the position I took in the stock (at a nice profit, by the way) it rose even more quickly, to the point that I decided to shift it out of my active list. The stock’s upward trend continued almost unabated, driving the stock to a high around $110 in the first quarter of the year before finally dropping back a bit to hover around $100 for most of this month. That drop of about 10%, and seeing the stock consolidate around its current level, prompted me to take another look at the company’s fundamentals and its value proposition. There could be a nice opportunity to work with if you prefer to work with a shorter-term momentum method; from a value-oriented approach, I would still prefer to see the stock offer a better price. Here’s what I found.
Fundamental and Value Profile
Eastman Chemical Company (Eastman) is an advanced materials and specialty additives company. The Company’s segments include Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. In the AFP segment, it manufactures chemicals for products in the coatings, tires, consumables, building and construction, industrial applications, including solar energy markets, animal nutrition, care chemicals, crop protection, and energy markets. In the AM segment, it produces and markets its polymers, films, and plastics with differentiated performance properties for end uses in transportation, consumables, building and construction, durable goods, and health and wellness products. The CI segment leverages large scale and vertical integration from the cellulose and acetyl, olefins, and alkylamines streams to support its specialty operating segments. Its product lines in Fibers segment include Acetate Tow, Acetate Yarn and Acetyl Chemical Products. EMN’s current market cap is $14.4 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings grew about 12% while revenue growth increased a little over 8%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it is also a positive mark of management’s ability to maximize business operations. The company’s Net Income for the last twelve month was almost 15% of Revenues, with this number decreasing only slightly to about 13% in the most recent quarter.
- Free Cash Flow: EMN’s free cash flow is healthy, at $981 million. This is a number that has increased significantly over the past year, from about $650 million.
- Debt to Equity: EMN has a debt/equity ratio of 1.12, implying they use a fair amount of debt. The company’s balance sheet indicates their operating profits are more than adequate to service their debt, with good additional flexibility from cash and liquid assets.
- Dividend: EMN pays an annual dividend of $2.24 per share, which translates to a yield of about 2.21% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for EMN is $39.40 and translates to a Price/Book ratio of 2.56 at the stock’s current price. Their historical average Price/Book ratio is 2.8, implying the stock has somewhat limited upside. A move to par with its historical average would put the stock a little above $110, and right in the range of the all-time highs it hit earlier this year. That’s not horrible, but with only about 10% upside, it isn’t quite compelling enough to motivate a value-oriented, long-term investment.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend until March of this year and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock has significantly retraced its upward trend after hitting an all-time high around $112, and is now hovering around its 38.2% Fibonacci retracement line, which has provided a pretty solid level of support for the past month. That is a positive for momentum-based trading methods, implying a push back into the $110 area is a good possibility. In cases like this one, I also like to use moving averages (not shown on this chart) to identify a stock’s trends over different periods visually. The stock’s 200-day moving average, which is usually a very good indication of the stock’s long-term trend, is sitting right around the $93 level. That also coincides with the 38.2% retracement level if you extend the Fibonacci trend measurement over a two-year period, and with the 61.8% level shown on the chart above. Fibonacci analysts like to call that confluence; confluence means that multiple data points agree, which should improve their validity and reliability of that particular price level.
- Near-term Keys: If you like to work with trend-based, momentum-focused trading methods, the stock’s current price level looks like a very good retracement level. If the stock can pick up bullish momentum, a push to the $110 to $112 level is a very good possibility, and a push above $112 would mark a validation of the longer-term trend and should see the stock push to even higher levels. As a value investor, I would be far more interested in the stock at around the $93 level; at the stock’s current Book Value that would offer a more attractive value argument than what exists to day, and it would fall in-line with the confluence analysis I just outlined. A bearish trade, either by shorting the stock or working with put options, is a high-risk, low-probability approach right now, without a great deal of upside to offer in exchange.