How to Spot a 'Golden Triangle' Stock
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In this weekend's Masters Series, we're featuring an exclusive two-part interview with Stansberry's Credit Opportunities senior analysts Bryan Beach and Mike DiBiase. In the first installment, they explained how they uncovered the "Golden Triangle" chart pattern.
In today's conclusion, they discuss how the pattern is formed... reveal how many stocks qualify as Golden Triangle stocks today... and walk readers through a real-life example of a Golden Triangle setup with a well-known stock...
How to Spot a 'Golden Triangle' Stock
An interview with Bryan Beach and Mike DiBiase, senior analysts, Stansberry's Credit Opportunities
Sam Latter: We've discussed the "Golden Triangle" a good bit, but walk me through how this chart pattern is actually formed.
Mike DiBiase: Well, the first thing is we need to see a divergence in the price of a company's stock and the bond. The stock needs to have fallen at least 50%. The bond needs to not have fallen significantly. We have a proprietary threshold for determining this. That forms the first side of the triangle.
Then, we look for a confirmed uptrend. Of course, when you're doing back testing, you have perfect hindsight. You know the exact bottom. But when you're applying this criteria to the current Golden Triangle stocks, it's much more difficult.
When we see the share price starting to rise, that's when we want to get in. That's what forms the second side of the triangle. And the third side of the triangle is what tracks the bond price. We're going to continue to monitor these stocks to make sure the bond doesn't sell off. You can see the Golden Triangle formation in the graphic below.
Sam: Is this strategy limited to specific sectors or groups of stocks? In your back testing, did these companies show up predominantly in a single industry?
Mike: No, it's a total mixed bag. We didn't limit it by market cap or industry. We just looked for any publicly traded stock that fell more than 50% and included it in our study. Stocks from all types of sectors bounced. It could have been pet supplies, auto parts, pharmaceuticals, or oil and gas. It didn't matter. We saw the same results again and again, regardless of the industry.
Bryan Beach: Of course, at any given time, certain sectors are more hated than others. Right now, for example, the most hated sectors are probably commodities and retail companies. We have our eye on a lot of those companies as we're looking for current recommendations. During our back testing, at any given time, certain sectors were more out of favor than others. But right now, those two industries stick out.
Sam: I have to ask you guys one question that I'm sure is on everyone's minds... If and when the credit crisis that Porter has been predicting finally arrives, how will these stocks hold up?
Mike: First, you have to remember that all of these companies have already fallen at least 50% from their previous peaks. That means they have half the risk they did before they pulled back. So that's an added level of safety margin to these recommendations.
But the other thing to note is that following the crash in tech stocks in 2000, value stocks – as measured by the iShares Core S&P U.S. Value Fund (IUSV) – fell just 2%, compared with a 50% collapse in growth stocks – as measured by the iShares Core S&P U.S. Growth Fund (IUSG). And five years following the crash, value stocks outperformed growth stocks by more than 10 percentage points.
Sam: How many stocks qualify for the Golden Triangle list today?
Mike: Right now, about 50 stocks are on the list. That seems to be about average through our back testing.
Since starting this study back in June, we've seen some of these stocks already start to pop higher. While those companies are becoming too expensive for us to invest in, other stocks are continuing to pop up on our list on a daily basis.
Sam: When it comes to back testing and having that perfect hindsight, anyone could look like a genius. Can you walk us through a real-life example of the Golden Triangle strategy at work?
Bryan: Sure. The September issue of Stansberry's Investment Advisory is a great real-life example of the Golden Triangle strategy.
Let's go back to the summer of 2007. Ralph Lauren (RL) shares were sailing, trading around $100 a share. The company had a rock-solid balance sheet. It was generating a lot of cash flow. And it had one of the world's most valuable brands – Polo. And it was capital-efficient, a trait that longtime readers know we look for in high-quality businesses.
But revenue began to slip... And the next year, the financial crisis hit. The stock market tanked and took Ralph Lauren shares with it. Investors lost faith in the clothing maker.
Sam: It wasn't a great time for people to be buying $100 Polo shirts.
Bryan: Right. And while pandemonium played out in the stock market, the bond market seemed unconcerned about Ralph Lauren. That's the important thing to note... There was a divergence.
Ralph Lauren shares got clobbered, falling 70% from their mid-2007 highs to the bottom in early 2009.
During that time, the bond market remained mostly unconcerned. Ralph Lauren bonds fell about 15% from their highs and recovered within five months.
It's worth noting that bonds fall less than stocks because they're better securities to hold in times of trouble. Bondholders have a more senior claim on the company's assets than shareholders. When a stock falls almost five times more than the bond, it's clear that the stock and bond investors disagree.
And just like we saw with our other Golden Triangle stocks, in the two years that followed, Ralph Lauren shares rose 300%. Three years later, they were up 450%. Ralph Lauren outperformed almost every company in the S&P 500. Stock investors finally began to evaluate the company the way that bond investors always had.
Back in September, Mike and I saw the same divergence happening with Ralph Lauren that we saw 10 years earlier. The reasons were different – everyone hates retail today. We've been writing about the "death of retail" for years. Ralph Lauren sells most of its product through department-store chain Macy's (M), which has been closing a lot of stores. The stock market grew concerned. Again, these are legitimate headwinds.
But we saw the divergence. While the stock had fallen 53% from its previous highs, the bonds were actually trading above par. We spotted what we believed was a Golden Triangle setup, so we recommended buying shares in Stansberry's Investment Advisory.
This is a real-life, real-time example. With back testing, you know the perfect time to buy. You have the crystal ball. We didn't have that with Ralph Lauren. For a while, it didn't look like the trade was going to work out. Shares didn't take off right away. They moved sideways, and then down a little bit. But just three months later, we're up almost 15% on the position, and shares look like they're on their way back to their previous highs.
Sam: One of the things that has set Stansberry's Credit Opportunities apart from other bond newsletters is that your team has built an entire proprietary rating system of your own. Sometimes, your ratings don't align with other ratings agencies like Standard & Poor's or Moody's. Does that factor in with the Golden Triangle strategy?
Mike: Generally, no. We aren't applying our bond rating when we're looking for Golden Triangle stocks. We're focused more on how the bond and stock prices are performing.
But in Stansberry's Credit Opportunities, we're focused on finding "outliers" in the bond market – companies whose bonds we feel are being unfairly discounted.
And the Golden Triangle strategy is looking for the same types of outliers. These opportunities don't come up too often. Like I said, we only have about 40 or 50 companies that qualify for this list at any given time. when you look across the population of all publicly traded stocks, this only happens about 0.3% of the time – three out of every 1,000 stocks qualify as Golden Triangle stocks. So I certainly consider the stocks we're recommending to be outliers as well.
Bryan: And remember, the bond rating takes into account all kinds of things on the balance sheet and with regard to cash flows.
Naturally, once we have our list of 40 or so Golden Triangle companies and we're trying to narrow them down, we'll look closer at some of the same factors we look at when making a stock recommendation in any of our newsletters.
But we aren't using our rating system to single out certain companies. Our back testing was primarily to compare bond investors and stock investors. And as we've explained, the results were phenomenal when we applied our criteria.
Mike: What makes the strategy so compelling to me is that not only are the results incredible, but the strategy itself is simple.
Now, you do need access to a lot of bond data to find these Golden Triangle opportunities, and that's not cheap. And we use these data to see how the bond market values a company's bonds versus how stock investors are valuing the company's stock. When we see a huge divergence, we're banking on the bond guys being right, because we think they do a better job at evaluating a company's long-term prospects.
Sam: How much data are we talking about here?
Mike: Each month, I download about $30,000 worth of data. You need access to bond data to study all the bonds. I pull data on 40,000 separate bonds every single month. And in doing that research for Stansberry's Credit Opportunities, we're also using that data to look at the bond prices of the companies that we find for the Golden Triangle research.
Bryan: I'd like to take the opportunity to brag about Mike for a minute. He has been working hard on Stansberry's Credit Opportunities for the last two years, and he's a major reason behind the track record we talked about – up 23% annualized, while buying a big basket of junk bonds is up less than 5%.
Most of the time, the bond market and ratings agencies like Standard & Poor's, Moody's, and Fitch do a great job. They're pros, and they know what they're doing. But Mike does a great job of finding these outliers and capitalizing on them.
The research Mike produces in Stansberry's Credit Opportunities is some of the most impressive stuff that we as a company are publishing. Our data providers, including Bloomberg, have really cracked down. We joke about it, but Mike downloads so much data that he's actually on a blacklist. They asked him, "Hey, what are you doing with all of this data?" Clearly, even among Bloomberg's sophisticated client list, which includes almost every professional investor, Mike's thoroughness stands out.
And Mike and Bill McGilton take that thorough approach with Stansberry's Credit Opportunities every month. The Golden Triangle is an amazing discovery, and we're really excited about it. But I don't want to undersell the rest of the fantastic product you're getting along with it.
Sam: Earlier this week, you recommended your first two Golden Triangle stocks. Can you tell us a little about them?
Mike: I can't tell you too much about them out of fairness to Stansberry's Credit Opportunities readers. But I can say this...
Our first Golden Triangle recommendation has steadily grown its revenues over the past several years. It gushes cash. But it's in a hyper-competitive industry. Because of this, its revenues are expected to slow down a bit. Of course, stock investors have, in our opinion, overreacted. Shares have fallen more than 50% over the last 18 or so months. But bond investors aren't concerned at all.
The second Golden Triangle recommendation is a company with a long, rich history. Shares have been falling ever since President Trump was elected. Sales of its main product have slowed, which caused the company to miss Wall Street's earnings estimates. And as is the case with our first recommendation, we believe the concerns are overblown. The company sports thick margins and could pay off all of its debt in about a year. It's trading at historically cheap levels. But bond investors aren't worried at all.
We believe both of these companies could easily double from here over the next 12-24 months.
Sam: Thank you both for taking the time to talk with me today.
Bryan: Thanks, Sam, it's our pleasure.
Editor's note: History shows that when the Golden Triangle appears, 100%-plus gains are likely to follow... and quickly. When we showed Porter this research, he was stunned. As he told us, "I think this is probably the most brilliant idea I've ever seen us produce." Learn more about this incredibly powerful signal by clicking here.