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Monday, September 16, 2013 - 07:00

My Top 2 Picks From Carl Icahn's Portfolio

Monday, September 16, 2013 7:00 AM

Carl Icahn recently battled Michael Dell in during his bid to take Dell (Nasdaq: DELL) private, and although Michael Dell won, Icahn still made $70 million in six months.

Icahn is famous for investments like this where he takes an active role in trying to unlock shareholder value, but he is actually a successful value investor with a long history of success. His company, Icahn Enterprises, describes its strategy in simple terms:

"We seek to find undervalued companies in the Graham & Dodd tradition, a methodology for valuing stocks that primarily looks for deeply depressed prices. However, while the typical Graham & Dodd value investor purchases undervalued securities and waits for results, we often become actively involved in the companies we target."

In addition to reading what they write about their investing philosophy, we are able to watch exactly what large investors do with their money. Large investors, anyone managing at least $100 million, must provide the Securities and Exchange Commission (SEC) with a list of their stock market holding every 90 days.

When looking at Icahn's investments, we see that he is not as diversified as many other investors. In his SEC filings, he lists only 19 holdings, worth more than $21.5 billion. Individuals tend to be limited in the number of stocks they can own, so Icahn may be a better model to follow than a hedge fund with hundreds of different stocks.

Some investors scour SEC filings to unlock the methods of great investors like Icahn, who has a personal fortune of about $20 billion. I review these filings from a slightly different perspective. The list of stocks Icahn owns is short, but a few of the stocks are bound to be better than others. Because I have limited trading capital, I developed a system to find the best stocks. This is the same system I ran on the list of Warren Buffett's stocks several months ago.

Despite the small number of holdings, Icahn's positions are diversified across a number of industries. I found that his stocks offer market-beating returns with an average annual gain of 12.1% a year since the end of 2002, besting the 5.6% annual return from the S&P 500 index.

Right now, two Icahn stocks are strong buys, according to my system.

Mentor Graphics (Nasdaq: MENT) provides design software and hardware solutions for a variety of industries to automate the design, analysis and testing of complex systems software. Earnings have grown at an average of 38% a year in the past five years, but analysts expect a slowdown and are looking for growth of only 10% a year in the next five years.

Mentor has consistently beaten analysts' earnings expectations, and the company's customers are in industries that Icahn knows well. He might be buying the stock because he believes its products are superior to the competition, or there could be another reason. We don't know for sure, but we do know that cash flow growth and relative strength (RS) are above average for Mentor, making the stock a buy based on my system.

Cash flow is more predictive of a company's financial health than earnings, and RS shows how a stock is performing compared with the rest of the market. Value stocks can trade at low values for years before other investors catch on. Buying only when RS is high helps avoid this problem. RS is shown as a number between zero and 100, with 100 being the strongest and zero being the weakest. High RS means a stock is among the best performers in the market, and MENT has an RS rank of 100.

Netflix (Nasdaq: NFLX), a leading provider of Internet entertainment services, is also an Icahn holding. Earnings have been volatile. The company beat analysts' expectations by more than 20% last quarter, but missed expectations by more than 70% the previous quarter. Volatility may continue, but Icahn seems to believe the company will be a winner as the Internet television industry evolves.

NFLX has been one of the strongest stocks in the market over the past six months with a RS rank of 100 and gain of more than 60%. In the most recent quarterly report, the company reported that cash flow from operations increased almost 75% compared with a year ago, and free cash flow per share grew by 43%.

Action to Take --> Icahn has been a successful investor for decades, and his latest picks should build on his record of success. Consider following his lead and adding positions in MENT and NFLX to your portfolio.

This article was originally published at ProfitableTrading.com
My Top 2 Carl Icahn Picks

P.S. -- I've come out with a new free report that helps you understand exactly how you can beat the best gurus in the country at their own game. To get access to the free report, "How to Outperform Soros, Icahn... or Even Buffett," click here.

Michael J. Carr does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.