If I Could Only Buy Two Mario Gabelli Picks, These Would Be Them

There are a number of great investors who rarely get headlines. They quietly go about the business of picking winning stocks and help their investors acquire wealth. Mario Gabelli is one of those investors.

He began buying stocks when he was 13 years old. Now in his 70s, he heads GAMCO Investors, a $36 billion investment firm that has delivered average annual returns of 16.3% to clients since it was founded in 1977. The S&P 500 provided an average annual gain of 7.6% over that time.

Mario Gabelli seems to have a great deal of confidence in his ability to find winning stocks. He doesn't get a salary from GAMCO, and instead receives 10% of the company's pretax profit as "variable compensation." According to Forbes, in 2011, Gabelli earned $62 million, and before taxes, he has been paid more than $700 million by GAMCO since the firm's 1999 IPO.

Like many value investors, Gabelli believes in diversification. His most recent SEC filing showed that his firm had positions in almost 1,000 stocks. The largest position, National Fuel Gas Company (NYSE: NFG), only accounts for 1.32% of his firm's portfolio. By contrast, Wells Fargo (NYSE: WFC), the largest Berkshire Hathaway (NYSE: BRK-A) holding, accounts for 19.96% of Warren Buffett's portfolio. (See my recent article on my favorite Buffett pick here.)

Whether a portfolio includes thousands of stocks or just a handful, some are going to be better than others. Those "better" stocks have the greatest potential to outperform the market over the next six months.

To find these stocks, I developed a trading system that finds stocks with the best fundamentals and technicals.

Fundamentals are captured by cash flow. Revenue, earnings, dividends and other factors are important, but a number of studies have shown that cash flow is one of the best indicators of future stock market performance. I rank stocks by their change in cash flow and want to consider only the highest ranked stocks.

This same process is widely applied to price, and is known as relative strength (RS). High RS stocks, those that have performed the best over the past six months, tend to be among the best performers over the next six months. The system I use to select stocks combines RS with strong fundamentals.

Looking at Gabelli's reported holdings in his most recent filing, the two stocks with the most potential are The AES Corporation (NYSE: AES) and The Madison Square Garden Company (NASDAQ: MSG).

AES is an international utility company with operations in the United States, Chile, Colombia, Argentina, Brazil, Mexico, Central America, the Caribbean, Europe, the Middle East, Africa, and Asia. Analysts expect solid earnings growth from AES, and the chart below shows the stock is breaking out of a large basing pattern.

The potential gain in AES is about 20%, according to the chart.

Recommended Trade Setup:

-- Buy AES up to $13
-- Set stop-loss at $12
-- Set price target at $15.55 for a potential gain of 20% in 6-12 months

MSG owns the well-known Madison Square Garden, along with Radio City Music Hall and several other entertainment venues. MSG Sports owns and operates sports franchises, including the New York Knicks basketball team and the New York Rangers hockey team. MSG Networks and several regional sports networks bring in additional revenue for the company.

Gabelli has a long history of investing in media companies, and this seems to be a business he understands. MSG has been in an almost uninterrupted uptrend since its 2010 IPO.

It is difficult to find a price target on a chart when the price has moved almost straight up over time. Analysts that follow the stock for major Wall Street firms have price targets between $55 and $70, with an average of $61.56, about 9% above the current price.

In this case, I think call options will provide traders with a better risk/reward setup.

Recommended Trade Setup:

-- Buy MSG Nov 60 Calls at $2.50 or less
-- Set stop-loss at $1.25
-- Set price target at $4 for a potential 60% gain in 7 months

Insights from the world's greatest investors offer valuable information to individual investors. With my trading system, I am able to find the best stocks the world's greatest investors own right now and potentially enjoy gains from their biggest winners.

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