3 ETF-Supported Stocks With Room To Run

Joseph Hogue's picture

Thursday, June 15, 2017 - 2:00pm

by Joseph Hogue

I've made a career in spotting trillion-dollar themes in the market, first as an equity analyst and more recently as a pre-IPO investor.

Any analyst can create a cash flow model -- it's as simple as working through a company's financial statements to scrutinize the true cash-generating power of the investment. Every broker, research firm and fund manager has a team of analysts with their noses buried in 10-Ks and other documents.

But being ahead of the herd requires finding those market forces that will influence the direction of whole sectors, or even the entire market.

It's finding themes with the force of trillions behind them that create triple-digit return strategies.

I've used what is likely the most pervasive theme driving today's markets to find stocks with huge support. I then looked for upside price catalysts on these stocks to identify three names that could be the biggest outperformers of the year.

Are ETFs Taking Over The Market?
Hedge Fund investors and Mutual Fund clients are dropping expensive portfolio managers in favor of passively-managed exchange-traded funds (or ETFs). Global ETF inflows reached a record of $375 billion in 2016, an increase of 7.8% over the previous year. U.S.-listed ETF assets now total a staggering  $2.56 trillion. 

FactSet data shows that 2017 ETF inflows have already topped $203 billion through May, putting this year on track to pass $3 trillion in ETF assets. 

ETFs now account for 30% of the trading volume in stocks, double their trading volume a decade ago.
Investment consultant NEPC surveyed 74 endowment and foundation clients recently and found 40% had increased allocation to passive investment funds. More than a quarter of the respondents said they planned on further increasing their exposure over the next 12 months.

The stampede to ETFs is a pervasive theme, shifting money in every sector and asset class. Besides lowering trading costs, a good thing, it's also creating a huge market imbalance. 

That could be a bad thing, unless you know how to use it to your advantage.

The ETF Trend Could Be A Stock Picker's Dream
There are two potential effects of the shift to ETF investing by institutional and retail investors.
 

As passively managed funds, there is less market discovery in stock prices. If a portfolio manager is simply recreating in an index, there is very little or no analysis of the investment value of stocks in the index. When this is done on a massive scale and with trillions of dollars, prices and valuations can become distorted. 

This creates an opportunity for investors that are ready to spend the time to find individual stocks.

Since these funds passively invest in an index, a group of stocks that is only rarely changed, the buying in those stocks is relatively stable. This creates a level of demand for stocks in the most widely-held indexes with a stable group of funds continuously buying more shares as money flows into the ETFs.

That means stocks with a high percentage of shares outstanding held in ETFs should see a level of support on the demand from fund buying. An individual company may be listed in several different indexes, including groupings by sector, markets, geographic exposure and income.

Combine this market price support with a search for companies with upside catalysts and you've got a strategy with limited downside and the potential for strong returns.

3 Stocks With ETF Support And Upside Catalysts 

Newmont Mining (NYSE: NEM) is held by 84 ETFs for $3.35 billion of its $18.8 billion market cap, or nearly 18% of the shares. The price of gold tumbled late last year as hopes for an economic rebound and the threat of faster interest rate increases drove investors to risk assets. Prices have recovered this year but are still nearly 8% off their 2016 high. 

Thanks to heightened prospects for fiscal stimulus and delayed tax reform, gold prices could rally in the second half of the year if earnings and the economy fail to pick up. 

Beyond this economic catalyst, Newmont has several projects starting production that could increase output this year. It has already announced approvals for the Subika underground and mill expansion projects in Africa, as well as the Tanami expansion in Australia. Expansion projects are more than enough to cover slowing production at older mines, and management has guided to as much as 5.4 million ounces this year, against production of just under five million in 2016. 

Newmont's production profile is one of the most stable in the industry, with 41% in North America and 34% from the Asia-Pacific region, meaning just a quarter of production comes from geopolitically-uncertain regions. That makes the shares attractive to investors and ETFs looking for exposure to gold as a hedge against economic and market uncertainty.

Public Storage (NYSE: PSA) is owned by 97 ETFs for $5.8 billion of its $36 billion market cap, or 16% of the shares outstanding. Shares of real estate investment trusts (REITs) like PSA are widely held by ETFs.

REITs have been slammed over the last year on the potential for higher rates, which could temper economic growth and slow activity in the highly-leveraged real estate market. The broader Vanguard REIT ETF (NYSE: VNQ) has lost 1.2% while Public Storage has dropped 11%, both on fears that a weak consumer will pull back on storage expenses.

The selloff represents a buying opportunity in shares that have produced a compound annual return of 14% over the last 20 years. While storage is an undifferentiated market, the company's size gives it a financial advantage in marketing and operations against smaller peers. Downsizing baby boomers should support demand for storage at least into the next decade, and the company is pushing into New York and Florida which could act as catalysts for near-term growth.

NextEra Energy (NYSE: NEE) is owned by 104 ETFs for $7.2 billion of its $66 billion market cap, or 11% of the shares outstanding. Utilities are widely held within income funds as well as broader market ETFs.

NextEra offers investors a stable revenue mix, with 60% from regulated power and the remainder from its wholesale operations selling throughout the United States and Canada. The company is one of the largest producers of renewable energy in the country, and is positioned to take advantage of state renewable policy standards despite the withdrawal of the United States from the Paris climate accord. 

The company recently settled its Florida base-rate increases for 2017-2020, leading to better certainty on the regulated side of the business. The Texas Public Utility Commission's rejection of the company's planned acquisition of Oncor Electric Utility in April could drive another M&A announcement or other strategic catalysts.

Risks To Consider: Falling investor sentiment across an entire sector or theme could cause investors to dump ETFs, which would force the funds to sell components within the group.

Action To Take: Position in stocks widely-held by ETFs that enjoy both a natural market demand for shares and potential upside catalysts that could drive prices higher.

Editor's Note: Tap into the shockingly simple resource-investing strategy that the world's wealthiest men -- from Rockefeller & Carnegie to Warren Buffett & Bill Gates -- have been using for over a century to transform millions into billions...

Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.