Alpha To Dogs With Fleas: Evaluating Growth Stocks With Navellier & Associates Founder Louis Navellier

Deep value investor Tim Melvin had the opportunity to speak with Chairman and Founder of Navellier & Associates Louis Navellier. Based in Reno, Nevada, Navellier & Associates manages $2.5 billion in assets and publishes four investment letters focused on growth investing. Read more about Louis Navellier here.

Below is a full transcript of the interview.

Tim: Okay, everyone. We're on today with Louie Navellier of Navellier and Associates, one of the preeminent growth stock investors in the United States and indeed in the world today. Louie, thanks for spending some time with us this morning.

Louie Navellier: It's an honor to be here.

Tim: Thank you. We're appreciative. Now, you've been doing this for a very long time. I can remember when your newsletters were first becoming popular back in the '80s. We used to stand around the fax machine and wait for your newsletter to come in every day. You developed a very unique approach, and you were actually try to prove that the market couldn't be beat when you found, weren't you?

Louie Navellier: That's correct. I'm from Berkeley, California, so I'm fully trained in socialism and all, but basically what they teach you there is markets are efficient and we can't beat them, so we might as well index. So, I was behind the scenes building some of the first index products out there before- it was actually a portfolio design to match the S&P. I figured out I needed 332 stocks to match it. I kept beating it. So, I learned I was lied to, and there are anomalies in efficiencies in the market, and that's what we set out to document.

Tim: Okay. Can you talk about exactly what those anomalies and inefficiencies were?

Louie Navellier: Sure. There's something we calculate called an alpha, and that's the stock's return that's independent, uncorrelated to the market. And the only way you really get a high alpha is for something to zig when the market zags. So, there's something called a beta, which explains the stock's movement relative to the market, and the alpha's movement independent of the market. So, I set out to document that alpha exists, and I came up with a risk-adjusted alpha. I take it and I divide by the stock's volatility. And that's our top-secret reward:risk ratio. And all our data is now in the public domain, and in our databases, it's called Portfolio Grader Pro on our newsletter site called Stock Rater on our company's management site. So, we identified that alpha exists, but we have a risk-adjusted alpha.

Tim: Now, you've found that the stocks that provide this risk-adjusted alpha and higher returns tend to be the faster-growing companies.

Louie Navellier: Absolutely. There are several things that can create an alpha- stock buybacks are one, high dividend yields are another, especially nowadays, because the stock market yields more than the banks and the tenure treasury. But by and large, it tends to be companies with a strong cashflow, rising sales, accelerated earnings, a profit margin expansion. So, those are the ones we really lock in on. So, we have eight tried and true fundamental factors that we score stocks on to make sure they're fundamentally superior. We wanna make sure that the alpha's caused by fundamentals, not some gossip or being hyped by anybody. There's still hype out there. Like, nowadays, they're trying to say that Tesla's a short, because there's new battery technology that'll make Tesla obsolete. Well, that's just somebody that's getting to the media that's spreading this rumor. The truth is lithium batteries are here to stay for a while, and I'm sure Tesla has a right to go to the new batteries if they want. But somebody's using that to short the stock.

Tim: Okay. Now, you've got eight fundamental factors that you think are the most fundamental factors. Can you talk a little bit about those?

Louie Navellier: Sure. Well, one's very important now, which is sales growth, because there is no sales on Wall St, because the strong dollar pinch to profits and multi-nationals. So, the companies with real sales growth are very, very important. Then we have earning stability, then we have earnings momentum, we have cashflow, we have return equity, we have a profit margin expansion, and then, earning surprises. These are eight tried and true factors that have worked through thick and thin. I can tell you when there's a lot of merge acquisition activity, some of the things emerge from time to time, like the price of sales, things like that. But right now, those tried and true factors are very, very important, and they're working exceptionally well. The only issue out there is, the market's getting more narrow. So, the companies that score well on these factors are becoming increasingly scarce.

Tim: Now, you mentioned in the commentary on your website this week, that's actually bullish for your stocks.

Louie Navellier: That's correct, because when we get into a fundamentally focused market, let's just say the market's chasing the top 40% of the stocks. Well, then, that's nice, I can identify them and I'll benefit from those flow of funds. But I can tell you in January, we were chasing the top 22%, now it seems to be chasing the top 14%. So the market's kinda like a funnel. As the money starts to chase fewer and fewer stocks, and if I can still identify them, then I can break out well in the market. And this has been a great year for us. We've had three different portfolios in what we call the Category King section of the Wall Street Journal this year, so we're off to a great start.

Tim: Fantastic. You have a quantitative factor to your model as well, don't you?

Louie Navellier: Yeah. We have the alpha over standard deviation. We have our fundamental score of those eight factors. And then we blend them together to get our overall score. And it's actually 70% quantitative, 30% fundamental. And we grade the stocks in ABCD and F basis. A's being strong buys, very scarce. B's are buys. C's are holds. D's are sell, I call a D a Dog. F's a strong sell, I call that a dog with Fleas.

Tim: Dog with fleas. Now, this information's actually available to the public. They can use your material to grade their stock portfolio, can't they?

Louie Navellier: That's correct. It's in the public domain. Everybody just has to navelliergrowth.com, which is our newsletter site, and all they do is click on Portfolio Grader, and they have to register one time, but once they register, they can go and save portfolio. So, they can put in their IRA, their kids' account, their aggressive accounts- and they save them, and they'll be updated every week automatically forever.

Tim: Right. And they- if I remember, they can handle quite a lot of stocks, because I think I put 600 in there one time.

Louie Navellier: Yeah, there's 5000 stocks in the database. 600's a lot. So, there'll be a few pages.

Tim: Yeah, it was a few pages, I recall. Now, you touched on something real important a couple of minutes ago. You said that price to sales is working extremely well right now. Your model kind of changes the waiting of the fundamental factors from time to time, doesn't it?

Louie Navellier: That's correct. Internally, when we manage portfolios, we figure out what works in large cap, what works in mid cap, what works in small cap. Generally speaking, large cap stocks want earning stability, strong cashflow, margin expansion. When you get to the mid cap stocks, they kinda want the same factors, but they like to have some earning momentum, and earning surprises. And when you get to small cap stocks, they want a lot more earnings momentum and surprises. So, it's a little different. The big stocks are more orderly. They tend to be smarter. They tend to move in anticipation of what's gonna happen. The mid do that a little bit. They like to pop in the wake of earnings. And then the smalls are- cap stock- I call em bunny stocks. They sit, they hop, they sit, they hop. They kinda react around the quarterly earnings. What we wanna do is figure out what's working in each neighborhood and dial it in. Now, on our Portfolio Grader, we have eight tried and true fundamental factors, all important, but under management we really try to dial it in a little bit more precisely.

Tim: Okay. Most people would be better off running their portfolio through Portfolio Grader and just holding those ranked A & D?

Louie Navellier: Yes. And if someone has a pension, they can chase a-rated stocks, because a-rated stocks are fleeting. They only last 4-5 months on average. There's exceptions, like Apple, which I think has been at A for 11 months. But generally speaking, As are the best for your pensions. As and Bs are better for taxable accounts, because then you'll get more long-term gains, and if you can hold stocks that are 12 months and a day, you only have to pay the 23.8% taxes instead of 43.4. So, there's a few tricks up there, and we do want people to be as tax efficient as possible.

Tim: Mkay. Now, you and I talked a lot in the past. You always talked about coming into earning season, which, of course, we're in the first stage of right now, locked and loaded with the very best stocks. Can you describe what you mean by that?

Louie Navellier: Sure. That's very important now, because if you look at the top 50 stocks in the S & P, 70% of them are gonna have negative sales annual earnings. And it's a mixed bag out there, and it's largely because half the S & P's revenue is coming from outside the United States, and when your currency goes up 20% against your trading partners, sometimes it hurts the sales and earnings. So, it hasn't been good for the Proctors and Gambles or the McDonald's or the Cokes. Caterpillar had horrible sales, but they had surprisingly strong earnings from buyback.

GE has horrific sales, but they're doing- they're spending up capital. They're gonna have huge buybacks. So it's really a mixed bag out there, and we don't want companies that score good on one and poor on another. We want em to hit on all cylinders. So, we're gonna avoid a lot of those stocks that I referred to, and just lock in on the ones that are basically an oasis out there. So, that would include an Apple, it would include an Actavis, which is a generic pharmaceutical who bought Allergen, that's the botox company.

We do like biotech like Gilead. Biogen actually is interesting. It missed sales earnings, but they're still very strong. So it doesn't score on all our criteria, but on our large scale it scores well, so I added that recently.

Tim: Okay. Now, you have a very strong economics background, and you've worked for the fed for a period of time, as I recall. What's your view of the economy out there? We're just getting a mixed bag of information from-

Louie Navellier: Well, first of all, we had a staff economist at the fed named Janet Yellen, she has a higher position now, she was our fed chairman. Our Chief of Labor Congress, and I can tell you that they're not raising rates in my lifetime. And every time I say that, people would say, "Well, how long are you gonna live?" And, I'm planning to live to July, because my oldest daughter's getting married. But, I don't think they'll raise rates at all this year. And that's not me, that's the Boston fed, presidents of Minneapolis fed, president- and Charles Evans, the Chicago fed president.

The pen and paper, the four staff members, that work in this institute, explained why they can't raise rates. But, the fed has two mandates. One is unemployment and one is inflation. And we actually have deflation up there, because commodities are priced in dollars, and the dollar value going, prices go down. And so you have deflation and it forces out there. We especially see it in the wholesale prices. The job market, which is Yellen's specialty, she has a 19-component indicator, has a serious problem that, I don't know why people don't talk about it, but I'm gonna tell you. What it is, is, there's double counting the jobs numbers.

Most of the jobs they're creating nowadays are temps, rightly and wrongly. So, some ambitious person gets two temp jobs, they get counted twice. And then they match up their social security numbers and say, "Oh. I guess we made a mistake." So then they revise the numbers down. So, it wasn't so much the March payroll decelerated, it was the downward revisions in January and February. Furthermore, this double accounting in jobs isn't me. This is coming from the FOMC themselves. In 2013, they pointed out that the payroll survey was creating more jobs than the Broader Household survey. Household survey covers kind of, the cash economy.

Anyway, they pointed out the Household survey created more jobs than the Broader Household survey 2013, did this double counting. And that is why the fed removed their unemployment target, because the double accounting. And Gallop and other services, ADP are turning inward, and there's a job growth that the Department of Labor has. And speaking of the Household Survey, it declined 146,000 in March. So, we have a problem out there, and a big one. And she has no intention to raise rates, when the job market's decelerating, because that's her mandate, to do that. Obviously, there's anemic wage growth. You can raise minimum wage all you want, but it doesn't impact a significant portion of the people. I'm sure the people that benefit from that appreciate it. And there's just a real problem out there.

So, she's gotta keep rates low so the job market recovers and so inflation comes back. Right now we've got negative rates in Europe and Japan and money's pouring into America because we have positive rates, and this market force is shoving rates down. So they have no intention to raise rates this year. And then you hit the election cycle, and no one wants to raise rates going into the Presidential election. So, enjoy the environment. It's gonna be here for a while.

Tim: Okay, now the obvious question is, not too many people actually talk about this, but how does this end?

Louie Navellier: Well, I guess it ends in deflation. The stock market has historically liked inflation. And you can see commodity-related stocks, energy, steel, aluminum, agriculture, are all struggling because we have deflationary prices out there. And I realize some of the stuff is seasonal like energy is seasonal, tends to go up in the summer and it'll go back down in the fall.

But, the only two economies out there with raging deflation, which is the Euro-zone and Japan, actually have a booming stock market. So, it's very confusing to investors, but Europe and Japan are still pumping. Not Britain, but European Central Bank, and the Bank of Japan. And it's kind of silly to do all this quantitative easing and buy a bond with a negative yield. So what they're doing is, it's fueling the stock market. And the biggest problem is, so, the quantitative easing in other countries is fueling the stock market. Furthermore, companies are buying at these record-low rates and buying their stock bound.

We had $906 billion return last year in dividends and buybacks, and they're both running at a record high. So this is gonna continue, and the big multi-nationals in America can go borrow in Europe at ultra-low rates. I mean, several months ago, Apple bought in Europe at 1.3%, they recently bought at 70 basis points. So, as long as you can borrow at a lot lower rate than your internal return equity, you're just gonna keep borrowing and buying your stock back. So, this is gonna continue for the foreseeable future.

Tim: Okay. Now, that brings up an interesting question. Do your models work as well in international markets as they do here at home?

Louie Navellier: Well, international markets tend to be more spastic, to be honest with you. I think our system's worked amazingly well in China, because we like stocks are going up in a very smooth, steady manner on our quantitative criteria. But then they get a little bit too risky, and then we trim them before we sell them outright. I was on CNBC recently selling Bishop Holdings, which we think it's a good company, it's a lot better than Alibaba internet retailer.

But we were up 751% in our merging letter. It got increasingly volatile. I didn't like the last earnings report, even though it went higher on guidance. And it looks like its margins are being squeezed. So I got out of it. So, we'd been known to ride the Chinese stocks when they're safe and get off of them when they're volatile. You and I worked on that book, and we talked about Baidu in there, how Baidu was safe for many years and then it became volatile. So, as long as there are enough bubbles out there, and as long as the bubble builds slow and orderly, I think I can manage it.

But if the bubble, over the last two weeks, it's not my thing, but I think we've done very very good with China, historically, we've done well with Israel, but Israel's more of a tech-focused economy, very similar to the United States. And there are other countries we've done well in, like Argentina, they're always worried about their bonds, so the high-dividend stocks did well. So, you know, I'm very proud of how the system has expanded globally. But we're only buying the ADRs here to trade in the States. We don't wanna leave the United States, because of the higher transaction cost.

Tim: Okay. That makes perfect sense. Now, on navallier.com, one of your guys' express some concerns about China as a whole recently. Can you talk about that a little bit?

Louie Navellier: Sure. Well, Asian economies are different than American. You can look at a place like Hong Kong. They have housing bubbles every few years. And then it runs up for several months, it busts, and four months later everybody's back buying. So, it's not like United States. When our bubble burst, we might take 7-10 years to go back and stick our toe in the water.

But, there's definitely a bubble in housing in China. It's all down across the country despite their almost hundred metro areas. And there's this correction crackdown in China where they're trying to figure out who got money. So there's capital flight from the country. They used to go to Macau to gamble with the Chinese wan, exit with Hong Kong dollars, now they've opened up a link from Shanghai to Hong Kong, so their Hong Kong markets have gone up.

But, I have a kid on the West Coast at a fancy school, and I can tell you that most of his people in his dorm are all from China or other places in Asia, and I can tell you the parents moved as well, and they're buying homes sight unseen from Southern Cali to Seattle. They're bringing in capital, they're not planning on leaving. So, there's capital flight out of China. There's a correction crackdown. But the stock market became their only game after the real estate bubble burst.

And now that that's got a little frothy, they're trying Hong Kong, obviously still buy real estate in teh United States. So, it's interesting. And they're still gonna grow very, very fast. But the fastest growing economy right now is actually India. India spends a lot of money on food and energy, now they spend less, cause prices came down, so they're now running a rate-percent GDP growth.

Tim: Okay. And does your model work pretty well in India?

Louie Navellier: Yeah, we do, we do, but it's mostly the big banks in India. I don't have Tata Motors or anybody like that, I don't have Doctor Reddy, which is pharmaceuticals. So right now it's just been the banks predominantly. The folks in India have more disposable income, cuz they spend less money on food and energy.

Tim: Okay. Now, coming back to the US markets, your blog on your site, navellier.com, you described the US stock market as "having a washing machine condition" right now. I thought that was a great explanation. Can you elaborate on that?

Louie Navellier: Sure. What it is, is, Wall Street just loves to take profits in certain sectors from time to time. And they did this in October, I remember there was a big reverse on October 15, I remember the week before, they hit the semi-conductors 12% one day, then they went and hit the health care and the biotech, and that's exactly what's been going on now. So, they're hitting all those sectors, they're taking profits in the strong sectors.

But then when all the dust settles, that's where all the sales earnings are, so then all rights itself. The most important thing investors must know about this market is money is not leaving the market. It goes out and hides in high dividend stocks. Again, the market yields 1.9%. That's more than the bank, that's more than the tenure treasury. It's taxed at 23.8%, which is better than being taxed at 43.4 and interest. So, there's no reason to get out of the market if the market yields more than the equivalent. So, what happens is, the high dividend stocks have been the oasis out there, and we've had this rotational correction emerge going into the first quarter, and it's now in season. But I think when all the dust settles, the dividend stocks that have growth are going to be doing great.

I know Buffett just bought Kraft, one of our high-dividend stocks. That's the third time Buffett's bought out one of our stocks in recent years. He also bought out Heinz and Lubrizol. And then, there are the high-dividend stocks out there with earnings like Hasbro. So, again, money's not leaving the markets, just sloshing form one side of the tub to the other. So, the foundation of the market still remains very solid.

Tim: Now, traditionally, people tend to think of you as the super growth stock investor. But more, it's, you go to where the market's working right now, don't you?

Louie Navellier: Yeah. The thing that's weird about the market is it's going up on no volume. And it's going up because there's buying pressure on the surface from the buy backs and from higher dividends. I have a chicken stock that was my best-performing stock in January, Pilgrim's Pride, had a billion dollar and a half dividend.

Extraordinary dividend. Costco had an extraordinary dividend initiative, they're still increasing their dividends. So, that makes the foundations of the stocks stronger, when you return money to your shareholders. Furthermore, a lot of these companies, especially the multi-nationals, operate all over the world. So, they tend to have their US money in the US, and their money around the world somewhere else, whether it's Dublin or Luxembourg or Singapore, I'll let them figure that out.

But if they bring that overseas capital back to America, they gotta pay taxes again, because they have to pay differential between the overseas rates and American rates, and because Americans got a higher tax rate, they gotta play a little more when they bring it back. So, guess what? They don't bring the money back. But they often take that capital and buy their stock back. So, they just had- one of the news thing, that if Apple spun off its cash, it'd be the 17th biggest company in America.

So, the buyback activity of the dividends have made the foundation of the market safer than ever. And that is creating alpha. So we're documenting that, and we wanna continue to lock in on that.

Tim: Okay. Now, as this market's sloshing around, can you give us a look at what's some of your favorite sectors and maybe a stock pick or two might be?

Louie Navellier: Sure. Well, by far, it's especially chip companies. Skyworks solutions, SKWS, NXPI, and then, AVGO. These are the companies who make the energy-efficient chips in all our cell phones and devices. They make things that do the radio frequency and wifi chips obviously at radio frequency, when you go to your car, you wanna watch remotely and things, it often starts remotely. Those three chip companies are very, very important right now. And obviously, a lot of us buy Apple, so that's a good thing.

So, those'll be my favorite. I do like biotech a lot. It's just easy to take a pill than work out. It's cheaper to have a pill and procedure. I think the best example would be Gilead, GILD. Now, if you have Hepatitis C, it's very serious, and you can die a painful death in the hospital, or you can take a pill. It's cheaper than the health care system to take the pill. I do like Biogen, and they have a good pipeline. They did necessarily recently pull back. I'm buying that. BIIB. Another stock that's actually shockingly, a lot of people really like, is CVS. CVS is basically the new face of health care. I've had four in my life.

You just have to go to the doctors, get all the shots. You never go to the doctor to get shots now. You just go to Walgreens or CVS. A lot of people don't know that CVS will do chemo, too. And it's not every corner CVS, there's special CVS's for chemo. So, this is part of the healthcare outsourcing and efficiency they're trying to do. And rightly or wrongly, CVS is winning that. We do like the healthcare companies. Some of them got hit here hard, profit taking. There's a small one I really like right now, CNC, but the Anthems of the world and TM, the United Health Groups UNH are also very good.

As far as high-dividend stocks, there are two cigarette companies we do like. Reynolds American, which just pulled back, a good near-term buy. And then Altria, which is MO. Those are two big dividend stocks. We do watch REITs quite a bit. We do some health care REITs. This one is only for yield of the ACP. But, the Hasbro- but not as strong as we want. Health care returns office buildings, hospitals, so that's pretty much always occupied. So, interesting times we're in. If you noticed here, the lobby stocks are domestic. And I'm trying to stay more domestic.

Other domestic stocks would be Kroger, a very good buy now, Southwest Airlines, Lowe's, Home Depot. And this is all because of strong dollar profits and multi-nationals. The dollars' getting some back here in the last several weeks, because everyone's figuring out the feds not gonna raise rates. And by the way, that's not me, that's also the fed's futures. And that's actually FOMC's official forecast futures. So, when the feds- the feds can say anything they want, but we're all reading the forecast, and it says, hey, they're not raising rates. So, it's- anyways, the bottom line is, I like to be domestic as much as possible.

Tim: Okay. Now, the last time I looked at your ranking system, a couple of cyber security stocks showed up. That's gonna be the next big thing, is your model starting to reflect more cyber security potential?

Louie Navellier: Sure. We have VDSI, VASCO data security and Paolo Alto networks, PANW. Those are two core holdings of us and we like them very very much. The other interesting stock we have is Lockheed. And Lockheed is really more of a dividend play. And I know they make a fancy fighter jet, but Lockheed is really an IT company. And they help our governments spy. Our government has been spying on our enemies, like Angela Merkel of Germany, which, I didn't know she was our enemy. She got a little ticked that we were spying on her. The President of Brazil got ticked that we were spying on them. So, we're spying on a few other people too. But it's part of the intelligence apparatus out there.

Tim: Now, any chance that the feds just say, throws a political bone out there and just does 25 basis points and then backs off?

Louie Navellier: They might do a wine and dine, but I don't think they'll do it this year. I don't know if you saw Senator Schumer begging Janet Yellen not to raise rates. There is a tone in the progress development of the Democratic Party led by Elizabeth Warren, that rates are evil. And financial companies are evil. And how dare you charge rates. And it's not much different than Sharia law. I've gone over to the Middle East and made presentations and made my portfolios Sharia-compliant.

And I throw out the financialists because they don't believe in interest rates. So, it's interesting that we've somehow now got that in America, where you shouldn't charge rates. So, I find that very interesting. But, they definitely, for political reasons, you do not wanna raise rates going into an election, especially with a weak economy, a faltering job market, again, the household survey show the job decline in March. And also, we have, if anything, is a risk of deflation. There's a guy out there name Peter Orza, he was President Obama's budget director. And he pointed out our government can never charge more than two percent interest rates.

Right now they charge about thirty basis points between notes and bills and finance and bonds. The feds monetize 4.8 billion of our debt as well. But, Peter said if rates got to 2%, they'd have to tax everybody about 55 thousand and 100%. So, I know Bernie Sanders is running, I think it's gonna be very interesting to see what his platform is. But even Bernie, I don't think wants to tax everybody that high.

Tim: Yeah, these are gonna be some of the more interesting and fun debates to watch than we've seen in the last 20 years, I think. I know you've got some things to do this morning, any final thoughts for individual investors on how to navigate what is a very complicated and difficult market right now?

Louie Navellier: Sure. Well, it's very simple. Please, please go use our stock rater. It's free out there. The product is called Portfolio Grader on the newsletter site, navelliergrowth.com. And put your stocks in, see how they grade. And if you have A and B stocks, you can sleep at night. If you have a pension, try and keep it mostly in As. I just hope that stocks, buy better stocks. It's no different than running a sports team. You keep the best athletes on the field and when they get hurt or loose a step, you tend to cut them off, put em off the team. That's exactly what I do with the stock market.

So, there's one other thing that people have to do. After they grade their stocks, they have to keep at least 60% conservative, 30% mildly aggressive, 10% aggressive. If you had let the conservative stocks overpower your portfolio, you'll have smooth steady growth, you'll be able to sleep at night, and the beauty of the market now is, has yield. We have 1.9% yield in our blue chip portfolio.

I have another service called family trust where I get the yield even higher than that. So, the market yields more than the bank. It's tax-advantaged. So, take advantage of it. Don't be scared of it. And just diversify and hang on. I think it'll be fun. There's nowhere to go. The market is the only place. And if you want me to scare you, I'll tell you the whole market is benefiting from the buy back activity. And if I had any problem, the market might go poof and disappear. There's less stock out there outstanding.

I know we have a high beta like GoPro, Twitter, Alibaba. But the amount of stock outstanding continues to shrink from the buybacks. Lockheed Martin, which I mentioned, is retired over 35% in stockflow. So, that's common. AutoZone's retired almost 40% in the stock flow. You just can't keep buying the stock back and not expect the stock to go up and make earnings go up even more.