I regularly look at "oversold" stocks, as their prices can often represent good entries. At this time of year, with tax-loss selling and certain window-dressing activities in effect, it can be a particularly good use of time. With that in mind, I quickly screened the S&P 500 to find the 20 most oversold names.
Before I go on, I want to share my definition of oversold, with the caveat that there is no one correct way conceptually to define it. The system I use was invented by StockVal, which was acquired by ThomsonReuters a few years ago. The basic math is to evaluate the current price compared to a long-term moving average in the context of the volatility of the stock over the past five years. The output on this price momentum indicator can be thought of in terms of standard deviations from the norm. The 20 most oversold names ranged from -1.59 to -2.84. Without going into the exact scores for each name, here is the list of companies (click to enlarge image):
The stocks are sorted in descending YTD return by sector. A couple of things jump out at me. First, the list is quite diverse in terms of the sectors represented, with 7 of the 10 economic sectors having at least one member (there are no Materials, Energy or Financials). Second, the list is divided into winners taking a pause and perennial losers. A lot of winners are coming under pressure these days due to the potential changes in taxation next year, as I described last week. Let's take a look by sector.
The Consumer Discretionary names definitely highlight the winner/loser point, with Ross Stores (ROST) and Dollar Tree (DLTR) on break, while Best Buy (BBY), JCP (JCP) and Apollo Group (APOL) all down by at least 50% in 2012 and even more over the past five years. ROST looks interesting to me, as though it's just been profit-taking as the estimates for next year are stable. This one is debt-free and trading at its 10-year median PE. DLTR has similar metrics. BBY investors are likely hoping for a take-out. From a technical perspective, this one is extended in my view, as the 50dma has been below the 150dma since March. JCP may look cheap to its assets trading at 1X TBV, but it will be interesting to see how the balance sheet holds up as they dispose of underperforming stores and liquidate inventory. Finally, APOL, unlike many of the perennial losers, has a strong balance sheet, but the for-profit education industry seems to have a bad business model. All three of these stocks are seeing next year's earnings estimates under a lot of pressure. Note also that there are large short-interests, especially in JCP.
Switching gears, Monster Beverage (MNST), the lone representative of the Consumer Staples sector, has come under a lot of pressure due to regulatory concerns. Not too long ago, it was rumored to be a take-out (Coca-Cola), but now it is sitting at 58% of the all-time high set in June. The valuation has returned to its median since going public. Earnings are still expected to rise 23% next year, but analysts have reduced the outlook over the past few months.
In the Healthcare sector, we have a high-flier in Alexion Pharma (ALXN), a decent performer in Express Scripts (ESRX) and a laggard in St. Jude (STJ). ALXN was last year's best NASDAQ 100 stock, and it has been great in 2012 as well. I think that this is likely purely technical, as estimates for next year are robust and rising. ESRX disappointed earlier this month with its 2013 outlook, but it is still expected to grow earnings double-digit. STJ hits close to home, as I have had this one in my Top 20 Model Portfolio all year, in varying size. Its reputation has come under attack due to quality issues with its ICD leads. The stock trades now at the lowest PE in at least 20 years, as investors are pricing in potential market share loss. On the other hand, though, their robust pipeline of new products seems to be forgotten.
Pitney Bowes (PBI) is the sole representative in the Industrial sector. The price has collapsed to levels not seen since 1991. I don't follow this one at all, but it has substantial debt (about 3.5X projected 2013 EBITDA) and earnings are in decline. On a positive note, estimates for next year seem to be stabilizing and short-interest, at 30% of the float, could provide support. The dividend yield is in excess of 13% and has increased in each of the past five years. The payout ratio is high at 71%, but the current dividend is only about 50% of free cash flow, with debt repayment being the only other major use of cash.
The three Technology names share a link to PCs. Intel (INTC) has the best balance sheet and is down a lot less, but it has declined to very inexpensive levels as indicated by the 4.6% dividend yield. I own this one in my Conservative Growth/Balanced model, having more than round-tripped it after buying it near 21 in January. I sold it out of my Top 20 model near 26 but will likely add it again. Sentiment seems to swing regarding the company's ability to transition towards smart phones and tablets, and it is overly negative currently. Hewlett-Packard (HPQ) seems to have overreacted to what is hopefully Meg Whitman's kitchen sink of a quarter that wrote down that awful Autonomy acquisition. She has lowered expectations enough that the stock looks interesting to me. Advance Micro (AMD), on the other hand, looks terminal to me despite new management. All three of these stocks are extended in their negative trends, which could suggest at least a good trading opportunity in the near-term.
Windstream (WIN) is the sole representative of the Telecomm Services sector. The 12% dividend may look enticing to some, but the company offers a terrible combination of a high payout ratio, substantial debt (about $9 billion) and declining earnings. Already the dividend is eating up 100% of the FCF through three quarters in 2012 ($441mm paid, $423mm generated taking CapEx from Operating Cash Flow and adding in property sales).
Finally, I recently pointed out how the potential changes in dividend taxation are hammering Utilities, and we sure see this in the high number of Utilities making the cut. Sandy may be playing a role as well. Most of these stocks are now offering yields 4.5% or greater, including PG&E (PCG), Duke Energy (DUK), Southern Company (SO), Consolidated Edison (ED) and Exelon (EXC). While Xcel Energy (XEL) is just 4.2%, this is one of the faster-growing of the group and has increased its dividend in each of the past five years. EXC has seen its stock crater along with earnings this year and stands out as the worst performer over the past five years by a substantial margin. DUK is under scrutiny by regulators following the post-merger CEO change.
Buying significantly oversold stocks can lead to good long-term entries or favorable short-term trading opportunities. But one can't blindly buy oversold stocks, or the portfolio will be filled up with Enrons and WorldComs. Hopefully this list and my comments have provided enough information to help the reader decide if a deeper investigation is warranted.
Disclosure: STJ and INTC are in one or more models managed by the author at InvestByModel.com. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.