You Can Profit From Patterns – Especially in Health Care

Driving an ice cream truck and binge-watching game shows... Michael Larson's big moment... You can profit from patterns – especially in health care... Most investors avoid this space... Starting now, 65% upside in a Puerto Rican health insurer...

As a broke ice cream truck driver, Michael Larson needed a change of luck...

And that's exactly what he got – at least briefly.

In the early 1980s, Larson couldn't keep a steady job. He spent most of his days driving a Mister Softee ice cream truck around southwest Ohio, trying to make ends meet.

At night, he would settle onto the couch at his home in Lebanon, Ohio, to watch infomercials and his newfound love... game shows. In fact, he was quite addicted. As Larson's common-law wife, Teresa McGlynn, recalled to This American Life years later...

Michael was so obsessed with his game shows and his televisions... We had an entire wall full of 19-inch, 25-inch televisions. And he would watch them all at once.

In September 1983, a new game show called Press Your Luck debuted...

A large, colorful gameboard made up of 18 separate boxes would light up randomly. Each box flashed either a prize or a "Whammy" – a cartoon character who reset the player's score to zero. Prizes included money, vacations, and even luxury goods like cars and boats.

Three players would take turns pressing their game button to stop the light. Wherever the light stopped determined the prize. Like many game shows, it was played in two rounds.

Larson liked the show... It looked easy, and people were winning money. He could use the cash. And even better, after watching many episodes, he made a critical observation...

The random blinking boxes weren't random at all. They followed one of five patterns...

Larson began recording the Press Your Luck episodes on his VCR so he could study the patterns more closely. For 18 hours a day, he would sit on his couch watching the replays.

He would follow the five different patterns... carefully noting which boxes contained the best prizes and when they would blink. Eventually, he could hit his "imaginary game button" at just the right time that the next light to blink would always be a square with a big prize.

Larson was ready to take his act to the real stage. And in June 1984, he got his chance...

Larson headed to the studio in Los Angeles wearing a cheap suit jacket and a 65-cent thrift-store shirt...

His appearance started off on the wrong foot, though... Larson hit a Whammy on his first spin. And he finished the first round in last place, sitting on only $2,500 in winnings.

But in the second round, all of Larson's hard work and hours of research paid off...

Once he controlled the board, Larson went 44 straight turns without hitting a Whammy. He took 47 spins overall, winning $110,237 in prizes – including cash, trips to Hawaii and the Bahamas, and a sailboat. It was the most winnings in game-show history to that point. (If you can spare 10 minutes, watch Larson's incredible run on YouTube right here.)

However, not everyone enjoyed watching Larson rack up the incredible gains...

CBS immediately accused Larson of cheating and threatened not to pay him. However, the producers couldn't find a reason to disqualify him... because he didn't break any rules.

Larson did nothing wrong. He simply learned the game better than anyone else. He conducted hours of research... noted the repetitive patterns... and used them to win.

Similar techniques can give analysts a leg up when it comes to equity research, too...

As regular Digest readers know, I (Thomas Carroll) spent nearly two decades on Wall Street before joining Stansberry Research. Specifically, I served as a "sell-side analyst."

Similar to Larson, in my role, I spent countless hours evaluating hundreds of companies for my big-money clients... I was looking to gain an edge that would help them make money.

Like Larson, analysts look for patterns in charts and leading indicators across financial statements. Depending on the industry, regular announcements might repeat, too.

That's especially true in the health care sector...

As a health care services analyst for many years, my team and I digested as much data as possible. We focused on the reports that moved stock prices the most – both up and down.

And each year, several health care calendar items repeated that could be traded. For example...

• National health expenditures are released annually in December, offering a macro view of health care utilization and spending. These numbers inform the following-year financials at health care providers, such as hospitals.

• Medicare inpatient payment changes come out in late April each year. They're changes to how hospitals will get paid, beginning on October 1 of the same year. Since Medicare is a big customer for most hospitals, these data are very important.

• Health insurance pricing decisions are estimated in September and October for the following year. This information provides analysts with a window into the expected revenue growth for managed care organizations ("MCOs").

• The American Society of Clinical Oncology holds its annual conference in late May or early June. Cancer-fighting clinicians present their results from studies and other information that impact many pharmaceutical and biotech companies.

It's the same story today. These types of calendar items – and many others – influence health care firms' operations across the board... and more important, their stock prices.

As an analyst, I enjoyed following one stock in particular...

It's a small health care company that most people have never heard of. It has never been a great company by any definition... But it serves a critical purpose for its customers and its employees.

Most investors ignore it. And at the end of my Wall Street career, only me and one other analyst followed the stock.

You see, over time, the stock doesn't simply go up like most investors and analysts like... Instead, it zigzags all over the place. It certainly isn't a stock for your retirement savings.

The company is Triple-S Management (GTS)... It's the Blue Cross Blue Shield health insurance company in Puerto Rico.

Two things right off the bat scare most investors away from Triple-S...

First, it's a health care company. And if I learned anything in my years in the industry, it's that investors are scared of the space. This fear remained consistent throughout my entire tenure as an analyst...

Investors fear the complexity of health care. It's also heavily regulated, which adds policy risk. Many investors simply avoid trying to put their money to work in health care altogether, arguing that the "government can dictate what profits should be."

But in my humble opinion, this is exactly why health care is a great place to invest.

And the second thing that scared away most investors is that it's in Puerto Rico. We're not exactly talking about a hotbed of corporate compliance and revenue growth. People have been leaving the island in recent years. And don't forget, the government declared its own version of bankruptcy three years ago. Investing in the territory comes with unique risks.

Most investors and analysts ignored Triple-S for these two reasons. The rest turned away due to earnings volatility that no one seemed to estimate correctly...

You see, with Triple-S, the quarterly earnings reports were all over the place...

The "medical loss ratio" ("MLR") is an important indicator for health insurance companies. It tells how much premium revenue is getting paid out to doctors and hospitals.

The MLR is an MCO's largest expense, typically equal to around 85% of the company's revenue. But it's also mostly stable... For most MCOs, the MLR only fluctuates a couple of basis points each quarter. And even these small changes can sway earnings in a big way.

Bigger, well-liked MCOs – such as Anthem (ANTM) and UnitedHealth (UNH) – prided themselves on MLR stability. Surprises were rare. In turn, that meant stable earnings for investors to enjoy.

But with Triple-S, the MLR was erratic... It would often move by percentage points, not just basis points. One quarter, it might yield an 82% MLR. And the next, it would be 87%.

Five percentage points doesn't sound like a lot. But since Triple-S generated more than $700 million in quarterly revenue, that could swing its pretax earnings by $35 million per quarter.

As a result, traditional valuation metrics – such as enterprise value-to-EBITDA and price-to-earnings ratios – weren't very instructive. They would change drastically as the quarterly results were volatile. They didn't paint the full picture with Triple-S.

Even though most investors steered clear of Triple-S, we knew the company was paramount to the territory. It provides much-needed health insurance for individuals, employees, and even Medicare beneficiaries. It also provides property and casualty insurance.

We were also comforted with the trustworthy management team. The people calling the shots at Triple-S knew the importance of their corporate role... And my team trusted them.

Finally, the company traded below its "tangible book value" ("TBV"). (Also known as net tangible equity, TBV is the value of all of a company's physical assets, excluding intangibles like goodwill. It's an accounting representation of the company's hard and liquid assets.) If Triple-S ever shut down, its liquidation would provide a positive return to shareholders.

That's crazy.

Even better, during my years as an analyst, my team and I spotted a pattern with this stock...

It exhibited a repetitive characteristic that allowed investors to profit, year in and year out, for more than a decade – if they were paying attention. The patterns in this valuation metric dictated where this stock would trade in the coming months. It was almost like clockwork...

By looking at Triple-S's price to tangible book value ("PTBV") ratio – simply the stock price divided by the TBV – we consistently and accurately predicted the stock's movement...

In the chart below, you can see our "buy" and "sell" ranges for the stock over more than a decade dating back to 2008. Our buy signals triggered when the PTBV dropped into a range of 55% to 65%. And our sell signals occurred when the PTBV was between 75% and 85%...

Pay particularly close attention to the "primary focus" section. That's the more valuable data range because as Triple-S matured, the company's PTBV became more stable.

When the PTBV dropped into the low 60s, it was time to think about buying. Conversely, when the PTBV climbed into the upper 70s, we need to start thinking about taking profits.

As the chart shows, this simple pattern worked many times over the years. It wasn't perfect – notice some of the extremes when the stock moved outside the ranges – but it always told us when to look deeper into Triple-S... to see if we should hold longer or buy later.

For a misfit stock that didn't behave operationally like its mainland peers, this Puerto Rican health care company served as a beautiful gift for short-term investors like us.

And more important, Triple-S illustrates why I believe health care is ripe for investing...

As I said earlier, many investors are scared of health care. They don't understand it. They think it can go away in an instant if regulators say so. It's a very complicated topic.

And Triple-S fits all these reasons to a "T"... Why would anyone spend valuable time and capital investing in a Puerto Rico-based health insurance company? That sounds awful.

But by spending a bit more time researching the company, a simple valuation ratio revealed itself. And it isn't just Triple-S... Many health care investments fall into this category.

Ultimately, our trading success came from finding the pattern – just like Michael Larson did on Press Your Luck. We found the financial indicator pointing the market to move the stock higher or take it lower. And many times, we used it to our advantage to earn steady profits.

Now, before we wrap up, I want you to take another look at the chart above... Notice that Triple-S is currently in buy range. As such, the story warrants a deeper look...

The company just reported earnings for the first quarter of 2020. They were good for Triple-S. The biggest negative was non-operational... It came from the firm's investment portfolio, which took a hit in the quarter (just like all of our portfolios!). Importantly, the company maintained its full-year earnings guidance. This is consistent with other large MCOs.

And as Triple-S works its way from its current 39% PTBV closer to 70% or above, investors should expect a rise in the company's share price of about 65%.

Sadly, Michael Larson died of throat cancer in 1999. But if he were alive today, he would undoubtedly appreciate the Triple-S pattern... and he might even put on the trade himself.

What to Take From Warren Buffett's Outlook

Empire Financial Research founder Whitney Tilson, who we quoted in Monday's Digest, joined our colleague Jessica Stone earlier this week to talk more about what investors can take from Warren Buffett's cautious outlook on U.S. stocks...

To watch this video, click here. And as always, to access all of our free videos as soon as they go live, be sure to subscribe to Stansberry Research's YouTube page right here.

By the way, Whitney's longtime colleague and friend Enrique Abeyta, who has joined Whitney at Empire Financial Research, just launched an exciting, new hedge-fund-quality research service. Click here for more information about becoming a charter member.

New 52-week highs (as of 5/7/20): Agnico Eagle Mines (AEM), Alamos Gold (AGI), Calibre Mining (CXB.TO), DocuSign (DOCU), Rollins (ROL), Sandstorm Gold (SAND), Scotts Miracle-Gro (SMG), The Trade Desk (TTD), and Wheaton Precious Metals (WPM).

In today's mailbag, feedback on yesterday's Digest... more comments on Porter's "Big Lie" Digest... and a good perspective on the points made by subscribers over the past few weeks. What's on your mind? Tell us at feedback@stansberryresearch.com.

"RE: yesterday's Digest 5/7/20, while I agree that tech is here and more dominating than ever, I got caught on a sentence that seems to epitomize child raising differences between today and my bygone era, Scott said: 'And then they both dial in at 7 p.m. to listen to the librarians at my son's school read a couple of children's books before kids go to bed.'

"Wow, I'm sure your school's librarian is a great reader, but the reading before bed is one of those memories I'll never forget my parents doing for me (I'm 61, so it was a while ago). All this movie, phone, TV time, while exciting, is not exercise and play... ya know, tire the kids out!

"I appreciate your writings and viewpoints, this one just got me thinking that while things change, many times not for the better." – Paid-up subscriber Peter B.

"After reading this I realize that Porter and I see the world very much the same. I first subscribed when I heard 'End of America 2000.' It made absolute sense to me. I remember thinking that the Fed was devaluing our currency and labeling it something else. It was before it was labeled QE. Listening to Porter it was so nice to hear someone agree with me. These days I am an Alliance member and today, once again, I completely agree with Porter.

'I hope you'll join me in calling out anyone who supports these tyrannical and unconstitutional new laws. I believe every American should willingly risk death before surrendering an iota of his liberty.'

"Once again, thanks again for standing up for what you believe in. I agree that we all need to stand up in the face of tyranny." – Stansberry Alliance member Jeff S.

"Porter is so full of it. He should go work at a Smithfield plant. Anxiously waiting for socialism!" – Paid-up subscriber Anthony V.

"Since Porter's 'Big Lie' Digest a couple of weeks ago, the point-counterpoint exchanges in the mailbag have been intriguing and thought provoking. I'm going to guess that a retrospective many months from now will show that there were bits and pieces of truth and wisdom coming from both sides of the argument. Yet, as uncertainty seems to be the one thing that we all can agree on, I personally have gained comfort by re-visiting a quote by Macaulay from his History of England:

No ordinary misfortune, no ordinary misgovernment, will do so much to make a nation wretched as the constant progress of physical knowledge and the constant effort of every man to better himself will do to make a nation prosperous. It has often been found that profuse expenditure, heavy taxation, absurd commercial restriction, corrupt tribunals, disastrous wars, seditions, persecutions, conflagrations, inundations, have not been able to destroy capital so fast as the exertions of private citizens have been able to create it.

"As a global community, each of us is going through their own private hell, so we must simply keep on going. The other side awaits and the journey will be less challenged if we approach it with patience, humility, forgiveness and love." – Paid-up subscriber Bruce C.

Happy investing,

Thomas Carroll
Baltimore, Maryland
May 8, 2020