Pick up this rare bargain

It’s hard to find growth stocks at a reasonable price in the US market, says Matthew Partridge. Here’s one that fits the bill.

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It's hard to find growth stocks at a reasonable price in the US market. Here's one that fits the bill.

One of the big problems with the US market at the moment is that the historically high valuations mean there are very few bargains around. Indeed, it is amazing to note that in the entire S&P 500 there are only 12 stocks that have current price/earnings ratios in single figures, representing just 2.4% of the entire index.

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The most interesting of these dozen is Micron Technology (Nasdaq: MU). It is currently valued at only five times 2018 earnings, the sort of valuation that you'd associate with a company that is struggling to stay alive.

However, instead of being on the brink of bankruptcy over the past few years, Micron has experienced breakneck growth, with revenue growing from $9bn in 2013 to $20bn last year a compounded growth rate of 22%. This growth is expected to continue in the short run, with revenue expected to reach $28bn this year.

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Earnings have also grown at a rapid pace, more than doubling since 2014. At the same time, the company has also beaten analysts' expectations in the past few quarters, and management has started to revise up its guidance, another positive sign.

Make money from memory

So why is this company still trading at a very cheap multiple of its earnings? The problem is that Micron manufactures the components involved in computer memory. This is a notoriously volatile industry that is prone to boom-bust cycles that can leave firms struggling. It is also facing competition from low-cost manufacturers. However, if you look at the financials, you can see Micron has done a decent job of staying ahead of the competition, with gross margins of more than 40% and double-digit returns on capital.

The company has also been working to stay at the cutting-edge of technology. It recently unveiled a new 3D memory-storage chip 50% faster than its current products, which will help smartphone manufacturers add memory-intensive features such as facial recognition. At the same time it has been working on keeping costs under control, and making moves to diversify into areas such as cloud storage, in preparation for when memory markets turn down.

Micron's shares also look attractive from a technical perspective, as they are only slightly below their 52-week high and above their 50-day moving average. Overall, I'd suggest you buy Micron at $48.31. While IG Index's minimum is £0.24 per $0.01 (or £24 per $1), I'd suggest you consider a slightly higher level of £30 per $1.In this case, I'd suggest a stop loss of $32, two-thirds of the current price. This gives you a potential downside of £489.30.

How my trades are doing

This last fortnight demonstrated the danger of short-term trading. Almost immediately after we went to print two weeks ago, the S&P 500 rallied and has now gone above the 2,773 level that I put as the stop loss on our short position. This leaves us with a loss of exactly £500. Worse, bitcoin has rallied to $10,697, not that far from the level at which I tipped it. This means the notional profit from the trade is now only £132. Both IG Group and Renault have gone up slightly, increasing our profits to £452 and £223 respectively, while Hammerson continues to fall, which means our losses are £228.

However, Petrobras continues to soar, with the New York-listed ADR rising to $14.39, more than 80% higher than the level I originally tipped it at last summer, producing profits of £820. This is partly down to a rising oil price, but also due to several Brazilian politicians openly talking about selling the government's stake in the oil company. This pushes the profit on our open trades (excluding the S&P 500 short) to £1,344. This is a bit more than the losses on our closed trades of £1,014, leaving us with an overall profit of £330.

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With our remaining positions, I'm going to stick with the status quo for IG Group and Renault. I'm also going to give Hammerson one more chance, but if it doesn't start improving, then I will recommend that you take your losses. I still think the bitcoin bubble hasn't fully burst, so I recommend you sit tight for now. The big question is Petrobras. At ten times 2018 earnings, and at a 7% premium to book value, it is no longer a value play. However, it still trades at a big discount to other major oil companies. So I'm going to increase the stop-loss to $12 (the 50-day moving average).

Trading techniques: why it can pay to follow the shorts

Looking at recent price changes is one way to measure sentiment. But another way to do so is to look at the behaviour of short sellers. Short sellers bet on the price of a share falling. They do this by borrowing a share from its owner and then selling it to a third party, hoping that they can buy it back at a lower price. Short interest measures the number of open short positions over the total number of shares. So if a company has a short interest of 10%, it means that short positions are equal to a tenth of the total shares outstanding.

A high short interest implies the market has a heavily negative view of a company, though the investment implications of this vary depending on whom you ask. Contrarian investors would argue that a high short interest is a positive sign because it suggests a particular stock is oversold. They would also point out that short sellers are vulnerable to a "short squeeze". This is where a sudden rise in price leads to short sellers rushing to cover their open positions by backing their shares to avoid further losses. This in turn could end up pushing the price even higher, further increasing their losses.

However, studies suggest that in this case it might pay to follow the crowd (or at least one part of it). Paul Asquith of the Massachusetts Institute of Technology found that, between 1988 and 2002, the stocks that had the highest level of short interest subsequently lagged the market by 2.15% a year. One possible explanation for this finding is that, because short selling is psychologically difficult, only the best traders tend to go into this area.

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