Leon Cooperman is a hedge fund manager with $3.6Bn in AUM. He recently came on CNBC and shared his stock picking approach as well as stock picks.
I thought I would share his approach with you and hope you will find it highly valuable.
Start With GDP Estimates
Cooperman started his analysis with the macro picture and the rate at which the economy or the GDP is expected to grow annually.
Cooperman said growth in real GDP growth is approximately a function of growth in labor force and growth in labor force productivity.
[images style=”5″ image=”https%3A%2F%2Flp.yourcapital.net%2Fwp-content%2Fuploads%2F2017%2F05%2FGDP-Growth-v1-2.png” width=”560″ align=”center” top_margin=”0″ alt_text=”Real%20GDP%20Growth%20Formula” full_width=”Y”]
Cooperman mentioned that labor force has been growing at about 0.5% annually.
…And labor productivity has been growing at about 1.5%.
Hence Cooperman said that he expects real GDP to grow by 2% annually.
If you tack approximately 2% for inflation, you now have nominal GDP growing at 4% (nominal GDP = real GDP + inflation expectations).
Determine Level Of Interest Rates
Once Cooperman approximated the growth rate for the economy, he next focused on interest rates since rates can influence stock prices.
Cooperman said that since real GDP is expected to grow at 2%, fed fund rates should be at 2% as well (currently fed funds rate is at 1%).
The 10 year Treasury should be at 4% — same as nominal GDP (10 year as of this writing was 2.33%).
So Cooperman was suggesting that rates are a lot lower than where they need to be if you consider GDP growth.
Assess Market Valuation
The next step for Cooperman was to assess if the stock market was
- Appropriately valued
- Richly valued
He looked at the earnings estimates of the S&P 500, which were about $132. He then added $10 to $12 more if Congress passed the tax cuts.
That would increase S&P 500 earnings to about $142.
[images style=”5″ image=”https%3A%2F%2Flp.yourcapital.net%2Fwp-content%2Fuploads%2F2017%2F05%2Fpickstocks_image2.png” width=”560″ align=”center” top_margin=”0″ alt_text=”S%26P%20500%20Multiple%20Formula” full_width=”Y”]
In this case, S&P 500 was hovering around 2,400 and that meant that if you invested in the S&P 500 companies, the multiple you would pay:
Multiple = 2400/142 (approx 17x)
Cooperman thought 17x stock market multiple was about right based on the level of interest rates.
Select Above Average STOCKS
He then looked at average valuation metrics for the S&P 500 companies. The valuation metrics he analyzed were earnings growth, dividend yield, debt to equity and price to book.
Cooperman said that earnings for S&P 500 firms, on average, were growing at 5% and the dividend yield was approximately 2%, price to book was about 3x and debt to equity 38%.
He said when picking stocks, he looks for companies that outperform the averages and are trading at a discount.
For example, here is how he analyzed Alphabet (GOOG).
[images style=”5″ image=”https%3A%2F%2Flp.yourcapital.net%2Fwp-content%2Fuploads%2F2017%2F05%2FGoog-Analysis.png” width=”560″ align=”center” top_margin=”0″ alt_text=”Cooperman’s%20analysis%20of%20Alphabet%20(GOOG)” full_width=”Y”]
He performed a similar analysis for Facebook (FB) and thought Facebook was also a buy because of its strong competitive position, fortress balance sheet and compelling valuation.
Some of Cooperman’s stock picks:
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But even smart people miss out on a few opportunities.
Cooperman regretted selling Apple Inc (AAPL) due to concerns about Apple losing its competitive position. As a result, he missed out on the robust AAPL stock rally.
Check out the 70+% APPL upward move since May 2016…Wow.
[images style=”5″ image=”https%3A%2F%2Flp.yourcapital.net%2Fwp-content%2Fuploads%2F2017%2F05%2Fpickstocks_image3.png” width=”1330″ align=”center” top_margin=”0″ alt_text=”AAPL%201%20Year%20Upward%20Move” full_width=”Y”]
…But hey, nobody’s perfect…even legendary Leon Cooperman!