4 $5 Stocks Screened To Limited Downside

by: Alan Brochstein, CFA

This is the time of year when speculating in lower-priced stocks has some appeal. Tax-loss harvesting and window-dressing have passed, and people seem more open to taking risk early in the year. While I think that it makes sense to spend time thinking about $100 stocks rather than $5 stocks, I know that I am in the minority, at least among individual investors. On the flip-side, since a lot of institutions won't or can't buy stocks below $5, sometimes there are some market inefficiencies that suggest digging in.

A couple of things captured my attention recently, leading me to want to explore some potential low-priced ideas. First, fellow Author Joe Springer published a "Pro" article on TravelCenters of America (NYSEMKT:TA), suggesting three reasons it might triple. The stock has rallied from $5 to more than $6 (intra-day high) since it was published, with the volume off-the-charts for the past three days. Second, I saw today that K-Swiss (NASDAQ:KSWS) is rumored to be likely to be acquired, sending the stock in after-hours from 3.19 to 5. A great year all in a matter of hours!

It is this latter example that ties into my bigger strategy, as I think that M&A could be a larger influence this year. Many of the clouds that have been hanging over businesses have been lifting, but we are unlikely to get a lot of economic growth. No, buying growth is likely to be a popular endeavor.

Those who know me know that I don't traffic in sub-$5 stocks too frequently. I think that the lowest price currently on my watchlist of 100 stocks is about $9! Now, that doesn't mean I am not familiar with some $5 stocks, as many of my mistakes over the years reside there.

My approach to looking at low-priced stocks is to use the low price as a signal. Low is usually bad, unless it isn't likely to go lower. Then, suddenly it looks more like a potential call option. So, how can we find some low-priced stocks that may be near some sort of floor?

The first thing I did was create a suitable universe, using Baseline to screen the Russell 3000 for all stocks below $5 but with a market cap greater than $100mm. I then looked for three attributes that might serve to bolster the valuation: Tangible book value, earnings and a strong balance sheet.

Tangible book value is the difference between assets and liabilities, adjusted for soft things such as "goodwill" or "intangibles". If the lights go out, these things may not have that much value, as they aren't easily turned to cash. Now, this is no magic bullet, as tangible book value is not necessarily accurate or easily achieved in a fire-sale (think of inventory liquidation or factory sales), but it is a measure.

Earnings, and I am being a bit lazy here because this is just an accounting concept, can help a stock obviously. Cashflow is probably more important than earnings, but EPS is a short-cut that I will use. Here, though, things can get tricky. A loss over the past year or even the past quarter isn't the end of the world. What we really care about is what we don't know but what we can try to forecast: The future. So, a company that is profitable is going to be a lot less risky than one that burns cash.

Finally, it's quite rare that companies that go bankrupt have no debt. If one is trying to mitigate downside risk, it pays to minimize debt. Actually, it goes a bit deeper, as often there are liabilities that aren't debt. Even more complex are "off balance-sheet" obligations that might not be reflected in the financials, like lease exposure or purchase commitments which can burn a shrinking business.

So, with a huge caveat that screeners make mistakes and that they won't give us the exact information we need, I did attempt to narrow the universe of some 270 or so sub-$5 stocks to come up with a few interesting ideas. There were actually too many, so I focused on stocks not too far above their 52-week low or their 200-dma. Keep in mind that these aren't recommendations. Here they are:

The stocks are sorted by their distance from their 200dma. Only the last one is above the 200dma, and it's only 26% above the 52-week low. I included trailing sales growth, with one stock seriously shrinking but the rest muddling along. I also included the YTD price changes (through 1/15), with most starting 2013 weakly.

Tellabs (NASDAQ:TLAB) is a dinosaur, no doubt, but it's not burning cash. Of note, the telecom equipment company paid a $1 special dividend late last year - it's not nearly as bad as it looks on the chart. This bad chart may actually be contributing to its lackluster performance of late. They just promoted a long-time employee to CEO. Insiders own about 10% of the company. How cheap is it? Even after the $1 special dividend, there is about $1.50 per share in net cash. Value manager Third Avenue just reported a 9.6% stake.

Bebe Stores (NASDAQ:BEBE) is a brand that has seen better days. The 74-year old Founder and Chairman just relinquished the CEO role to an outsider (from Lacoste North America) and owns over 50% of the company. This one has almost $2.50 per share in cash and investments net of debt as of 9/30. Capital spending was a bit elevated in FY12 due to the purchase of their distribution facility, which I think may be worrying some investors.

Power-One (NASDAQ:PWER) is also stuffed with cash at over $2 per share, though this is likely declining somewhat as the company announced a 15mm share repurchase authorization in October. Here, capital spending has been tame, so the company is kicking off significant free cash flow. Insiders own only 3%, but Silver Lake owns almost 1/3 of the company. In early September, the company, which makes inverters used in solar applications, was looking for a buyer according to the Financial Times' Alphaville (registration required). The stock trades at about 10X projected 2013 EPS.

RTI Biologics (NASDAQ:RTIX) seems interesting. The company makes orthopedic and other surgical implants to repair and promote the healing of bone and human tissue based on donated human and bovine tissue. The company did recently receive a warning letter from the FDA, which is concerning, and it also continues to litigate claims related to BTS, a tissue recovery business that ran into trouble. Insiders own about 6% of the company, including almost 2% for CEO Hutchison. This company has about $1 per share in cash.

So, hopefully I have given you a few ideas to consider if you like low-priced stocks. I have tried to find some stocks that may have limited downside supported by earnings, tangible book value and a strong balance sheet.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.