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Avoid These 8 ETFs And Funds Most Exposed To Valeant

Valeant Pharmaceuticals (NYSE: VRX ) fell 51% yesterday and the stock still has further to fall . While direct share holders stand to lose the most, certain fund investors face significant downside risk as well. These investors may not realize the risk they’re taking due to the shortcomings of traditional fund research , which doesn’t focus on fund holdings. By analyzing each holding of a fund, we provide investors with deeper insight into the risk/reward of funds. Our predictive ratings for ETFs and mutual funds give investors a different perspective as they are based on the quality of the fund’s holdings . Figure 1 shows the 10 ETFs and mutual funds that allocate significantly to VRX and could pose a risk to investors’ portfolios. Figure 1: Funds With Exposure To and Risk of Decline from Holding VRX Click to enlarge Sources: New Constructs, LLC and company filings Sequoia Fund (MUTF: SEQUX ) allocates just below 25% of its assets to Valeant. Diamond Hill Select Fund (MUTF: DHTAX ), FundVantage Private Capital Management Value Fund (MUTF: VFPIX ), and Catalyst Insider Buying Fund (MUTF: INSAX ), earn a Dangerous-or-worse rating in part because of their poor holdings like VRX, but also because each fund charges investors high total annual costs. It’s not all negative though. Nicholas Fund (MUTF: NICSX ) and Global X Guru Index ETF (NYSEARCA: GURU ) earn an Attractive-or-better rating because the quality of the entirety of holdings makes up for their allocation to VRX. The takeaway is: Buying a fund without analyzing its holdings is like buying a stock without analyzing its business and finances. Those who bought VRX based on trust in the company non-GAAP earnings did not understand the firm’s true finances, which showed Valeant was not a good business. Without analyzing each holding, inventors are taking on unnecessary risk when investing in ETFs or mutual funds. What Makes VRX Such A Poor Holding? Valeant had been in a bit of a limbo lately, as investors awaited the long delayed 4Q15 results. The company finally released its earnings today and the results were to be expected if you heeded our previous warnings. In the release, the company recognized the significant issues it faces after the termination of its relationship with Philidor, the cancellation of almost all price increases, and underperformance in several of its business lines. Not only did Valeant report weak results for 4Q15, but looking forward, the company guided for revenue ($2.3-$2.4 billion vs. $2.8-$3.1 billion expected) and earnings ( $1.30-$1.55/share vs. $2.35-$2.55/share expected) to come in significantly below expectations. Adding even more uncertainty, Valeant also revealed that it faces a risk of default if it is unable to file its 10-K with the SEC by April 29, which would break its reporting covenant in its bond indentures. The initial filing was due February 29 but has been delayed while Valeant investigates its business relationship with Philidor. Valeant is already in the process to extend deadlines for filing it 10-Q for the first quarter of 2016. Has The House Of Cards Finally Collapsed? As early as June 2014 , we pointed out Valeant was presenting itself in a misleading way. Ultimately, the company was relying on non-GAAP metrics to present its cash flow as highly positive, when in fact, the true cash flows of the business have been highly negative. This contrast between cash flow calculations is a topic of much debate between bears and bulls of Valeant and really gets at the heart of why non-GAAP metrics continually fail investors when analyzing a company. Analysis using Valeant’s reported “Cash Earnings” weren’t getting a true picture of the company, as can be seen in Figure 2. The company’s non-GAAP “cash earnings” have grown from $421 million in 2010 to $3.55 billion over the latest trailing-twelve months (NYSE: TTM ). In reality, free cash flow has been highly negative with a cumulative -$38.4 billion in losses over the same time frame. Cumulative non-GAAP earnings during the same time are $11.2 billion. Figure 2: True Cash Flow Provides True Picture of Valeant Click to enlarge Sources: New Constructs, LLC and company filings Valeant uses non-GAAP metrics to make its business look better than it is according to corporate accounting rules (i.e. GAAP) while burning through cash at an unsustainable and alarming rate. Non-GAAP Doesn’t Pay Down Debt As seen above Valeant’s true cash flow is not only much lower than Valeant would have investors believe, it is also largely negative. While management can prop up shares by touting non-GAAP results, those results don’t help pay debt covenants because the true cash flow is not available. Debt covenants may soon become just another issue in the already long list if Valeant defaults on its bond indentures. We already know Valeant has raised significant capital, as its debt has increased from $372 million in 2009 to $30 billion over the last twelve months. Without a sale of assets, one has to wonder how well Valeant can service such debt because it won’t be happening with non-GAAP “cash earnings.” Warning Signs Were All Around The warning signs at Valeant have long been in clear view, if you looked past the positive analyst sentiment, excellent non-GAAP results, and management rhetoric. In June 2014 , we noted that Valeant was presenting its business in a misleading way to bolster its takeover attempt of Allergan. Valeant claimed it was undervalued passed on P/E ratios when in fact the company was comparing its adjusted P/E to the unadjusted P/E of industry and market peers. Additionally, Valeant claimed its previous acquisitions were value creating when in fact the company’s return on invested capital (NASDAQ: ROIC ) has been in decline for quite some time. From 2009 to the last twelve months, Valeant’s ROIC has fallen from 15% to 5%. In July 2014 , Valeant made our list of companies with the most misleading non-GAAP earnings. According to GAAP, Valeant lost $866 million in 2013, but by their non-GAAP metrics the company earned $2 billion. This disconnect stems primarily from excluding the costs related to its acquisitions. Does it make sense to exclude the costs related to how you grow your business from how you measure profits? We find that fishy. We revisited the non-GAAP red flag again in November 2015,and the story had only gotten worse. In February 2016, we placed Valeant in the Danger Zone . After today’s share price decline, VRX is down 57% since our report. Stock Remains Overvalued, Even After 40% Decline After such a drastic price decline, one might think VRX is a bargain. Not even close. Those purchasing Valeant now would be buying a highly overvalued stock with a long history of misleading accounting. These are not exactly the characteristics of a quality investment. In order to justify its current price of $36/share, the company would need to grow NOPAT by 15% compounded annually for the next 8 years . In this scenario, Valeant would be generating $29 billion in revenue, greater than AstraZeneca’s (NYSE: AZN ) 2015 revenue. Even in an ideal scenario, in which Valeant focuses on internal growth and not destructive acquisitions, VRX still has significant downside. If Valeant can grow NOPAT by 9% compounded annually for the next decade , the stock is worth $23/share today – a 36% downside. Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Ways To Trade And Minimize Risk During Volatile Markets

Click to enlarge One of the qualities that can make investing in the stock market so exciting is how fast it moves and reacts. Prices are constantly changing, making it a challenge to keep up with what’s going on unless you’re sitting in front of a trading monitor. As a result, you might feel nervous about when to place trades, especially in uncertain market conditions. The good news is there are several easy steps you can take to better navigate your trading decisions during volatile markets. Here’s a look at some of the risks of volatile markets and a few ways to help you minimize losses. Risks Of Volatile Markets How much volatile markets may affect you can depend on the types of assets you hold, the total amount of money you have invested, and how you react to changes in the market. For instance, if you have highly concentrated positions, you are bound to face larger gains or losses due to having a high-risk portfolio. Some examples of risks that investors can be exposed to during volatile markets are listed below: Being over-concentrated in single-name stocks, specific sectors, or risky investment styles could lead to larger percentage declines in your portfolio versus major indices such as the S&P 500. Focusing too much on the short-term and holding excess cash could lead you to lose purchasing power due to inflation and under-utilize strategic trading approaches such as dollar cost averaging to methodically leg into investments on a regular basis. Emotions can be hard to control when you start to see red everywhere. Panic selling when a stock price temporarily declines on a sound investment could derail your long-term investment goals. On the other hand, if a company is failing and its stock price starts to decline rapidly, failing to lock in some of your profits or cut your losses could be quite costly. Getting too distracted by losses on your existing positions could also cause you to overlook favorable buying opportunities that could help you gain exposure to quality names trading at depressed levels before a rebound. Bring Your Asset Allocation Back In Line When the markets seem more unpredictable than ever, it’s a good idea to take a quick look at your portfolio’s asset allocation. Due to fluctuations in the markets, it’s possible your positions may have shifted out of line with your target ratios. For example, your stock-to-bond ratio may have shifted from a 60/40 split to a 50/50 split. Consider the benefits of rebalancing to help your long-term investment goals stay on track. It’s also worth checking if you are heavily overweight in any one area of the market. Concentration risk tends to rise in volatile markets. Reevaluate concentrated trading strategies such as those heavily weighted in single-name stocks or individual sectors. Dollar Cost Averaging DCA, or dollar cost averaging, in an investment method that involves investing a fixed amount of money in an asset on a consistent basis over time. It can be useful for investors who would otherwise choose not to invest at all or who are unsure about how to determine entry points into a stock or ETF. If you want to avoid having too much cash on hand, regularly investing a set amount of money into the markets on a monthly or biweekly basis can help you stay active, deploy cash, and avoid feeling like you’re missing out. Sell Stop Orders Do you want to protect your gains on a profitable position or limit your losses on a particular holding in today’s volatile markets? One common trading strategy many investors use is to place sell stop orders, otherwise known as stop loss orders. What a sell stop order does is it places an order to sell shares of a stock when its price reaches a “stop” price that you indicate in the order within a specified time frame. The stop price must also be lower than the current stock price to be valid. It helps to understand how a sell stop order works with this example: Travis owns 1,000 shares of Stock A. It’s currently trading at $100 per share. He has done well on his position and wants to lock in some profits if the stock price has a steep decline in the next couple months. Travis decides to place a sell stop order for 500 shares at a stop price of $90 for 60 days. If at any point during those 60 days Stock A drops in price to $90, Travis’ sell stop order will be triggered and a market order will be placed to liquidate his 500 shares. The actual execution price of the sell may not equal $90 exactly, but it should be pretty close depending on how quickly his broker is able to complete the trade. What if the stock price never drops to $90? The order would simply expire and Travis would be left with all 1,000 shares. The nice thing about a sell stop order is that you can set it and forget it during your designated time frame. No matter where you are or what you’re doing, you can rest assured that if your stock is on the decline and hits your stop price, your order to sell will be placed automatically. If you change your mind and no longer want to sell, you can simply cancel the trade if it hasn’t been filled before the order’s duration has expired. Buy Stop Orders A buy stop order has the same principles but in reverse. For example, if you are interested in buying shares of Stock A if it starts to show a rising trend in price, you can place a buy stop order. If the stock price reaches your stop price, your order to buy shares will be triggered at market. This can help you to make purchases before a stock price runs away and gets too high. Limit Orders Limit orders enable investors to purchase or sell a stock at a specific price (the limit price) or better. Let’s say Stock A is currently trading at $100. If you are willing to pay $99 or less to buy 1,000 shares of Stock A today, you could place a buy limit order with a limit price of $99. If your broker can meet or beat that limit price before the end of the trading day, your trade to purchase 1,000 shares will be triggered and executed. In other words, your execution price could be $99.00, $98.99, $98.95, etc. If the price stays above $99 the rest of the day, your order will expire. On the flip side, a sell limit order can only be executed at the actual limit price or higher. Stop Limit Orders Now that you are familiar with stop orders and limit orders, one step further is a stop limit order. In simple terms, a stop limit order is a combination of the two trade types and offers investors added precision. First, you designate a stop price, share quantity, and duration just like with a plain stop order. Next, you choose a limit price. The order will only be triggered if the stock price reaches the stop price and the order can be filled at the limit price or better.