Cheap Stocks Aren't Always Bargains - Barron's

Plenty of stocks look cheap right now, says Barron's Eric Uhlfelder, but that doesn't make them bargains. Once a stock slides below the $5 mark, it's usually a long, tough climb out of the bargain basement.

In 2008, many of the companies that became penny-stocks were household names, or at least well-known on Wall Street. They included retailers Rite Aid (RAD), Pier 1 Imports (PIR), Eddie Bauer (EBHI); radio broadcasters Westwood One (WON) and Sirius XM Radio (SIRI); auto-parts firms Dana Holding (DAN) and Noble International (NOBL); and financials Friedman Billings Ramsey Group (FBR) and Thornburg Mortgage (THMR.PK). Other notables were Citigroup (C), which has touched $0.97, and AIG (AIG), which has traded as low as $0.33.

Historical data suggests that risks rise as stocks break through certain price points on the way down. Low priced stocks could be subject to greater volatility on less liquidity, decreased visibility and research coverage and the potential for de-listing. The relaxation of listing standards will slow the pace at which stocks are forced off exchanges, but this just means more listed stocks will be trading for less than $1, not that the stocks are better buys. Moreover, margin-buying opportunities become restricted and many institutions cannot hold stocks trading below a set level like $5.

This is bad news for major companies that dropped below the $5 mark, like General Motors (GM), CB Richard Ellis Group (CBG), CIT Group (CIT), Office Depot (ODP) and Sprint Nextel (S).

Former Fidelity Magellan manager Peter Lynch is skeptical of single-digit stocks, and believes investors ought to sell immediately unless they are confident enough to buy more stock. "The notion that if it gets back to $10, I'll sell [virtually assures a] whole painful process [that] may take a decade, and all the while you are tolerating an investment you don't even like."

This isn't to say that low-priced stocks are without fans. But the key point for many investors is if you've done your homework and still like the stock, hold on. If not, breaking the $1 mark (or the $5 mark) is a good signal to sell.

Comments

[holmesnmanny:]

One thing these so-called "experts" don't realize is that you don't lose money until you sell a stock. Unless the company is gonna go bankrupt and you are sure of it, if you can afford to wait it out after a round of bad results, it's best to wait it out. If anything, it would be time to buy more when the stock bottoms out.

I never can understand the logic that everyone "must" sell before the stock bottoms out unless you want to lose all the money you originally put into the stock. In fact, after a round of bad news, if most people didn't sell, the stock wouldn't be going down, would it? If it's ok to just give up and lose all the money you put into a stock, then go right ahead and follow these experts advise. But if the stock has a chance to ever go back up, then don't give up, it's that simple.

Mar 29 06:53 AM

[Keith7777:]

i agree. what expert would have you sell 2000 shares of stock that you paid over 15,000 for? I will hold mine and continue buying weekly at $1 up to what i was paying originally.
What would they have me do? sell at a loss of 13,000 and take my 2000 and buy 8 shares of google?

Mar 29 12:05 PM

[Richard The...:]

Lets see now I bought 250,000 s of siri at .05 and now it's at .37..I know all these experts have helped us all into the poor house but I must tell you anymore I read this stuff and just laugh...I sold against the advice of my so called investment adviser and that was back in september....I guess I am just a dummy! LOL

Come on lady!

Mar 29 12:46 PM

[Joshua Ballard:]

I disagree with both commenters as you can cash out, regroup your cash and trade for better returns rather than waiting 10 years for C to return a 10% positive growth per annum once it stabilizes.

I would rather cash out my $15k at a loss of $13,000 and trade on my $2000 for the next 5 years, than wait for my now $2000 investment to hopefully return an average of 10% per annum.

For the $2000 to return to $15,000 (last year's levels) at 10% per annum will take approximately 20 years. Nevermind the next 20 years of new/recovering/emerging market growth that you've missed out on.

Wipe out the last 20 years and you've missed the insane opportunities of the tech bubble, the housing bubble, the financial bubble and the russian bubble.

I couldn't possibly imagine wiping out the next 20 years of opportunities.

Dollar cost averaging helps ease the pain, but you have to load up a considerable amount to offset the losses in percentage terms.

Mar 29 01:05 PM

[Tom Armistead:]

March 10 and the days that followed were a fabulous chance to buy beaten up stocks from $1 to 5, the Phoenix strategy, you could easily double your money in little more than a week.

Mar 29 01:25 PM

[truck_drive...:]

Another IDIOT poster from Barrons.....lol

Mar 29 01:47 PM

[satyr:]

The main trouble I have with this line of thinking is that it incorrectly attributes cause and effect. Stocks that go from $10 to $0.50 are not risky because they are under at $0.50. Rather, they dropped to $0.50 because they are risky. Once the price has dropped, the risk has been priced into the stock. In other words, the wise time to sell would have been before the drop, not afterward. So, if you want to buy a speculative stock, it may well be trading under $1. For those who are willing to tolerate higher risk, there is nothing inherently wrong with these because of their price. If you don't want a speculative stock, don't buy one, regardless of price.

I've also seen the analysis that shows how stocks that fall from $10 to $1 often take years to make it back to $10, and many never do. Aroo? Most stocks that are trading at $10 also take years to make it to $100, and many never do. Making a 10x gain in a short period of time is kind of rare - so pointing this out about low priced stocks is close to meaningless.

As for the potential for de-listing, this is a mirage. Aside from the relaxing of the rules, any company that wants to avoid this problem simply does a reverse split. At the push of a button, a $0.50 stock can become a $5 stock, or a $50 stock for that matter. Does that all of the sudden take the risk out of the company and make it investment grade? Honestly, people who use this kind of logic as an indicator have a weak grasp of accounting and securities regulation, in my opinion.

Mar 29 01:52 PM

[cos1000:]

"This isn't to say that low-priced stocks are without fans. But the key point for many investors is if you've done your homework and still like the stock, hold on. If not, breaking the $1 mark (or the $5 mark) is a good signal to sell."

This is one of the more absurd article conclusions I've heard in a long time.... The key point is if you've done your homework, still like the stock, then hold on. If you haven't done your homework, you shouldn't have bought the stock to begin with and these SP benchmarks mean nothing...

Mar 29 01:58 PM

[wholesalecd:]

Funny article and totally irrevelant to the volatility of these stocks. Look at Citigroup for example. She said it touched .97 but this stock has also tripled in the last three weeks from that bottom.

She's right that there are high risk with these stocks but she failed to mention that there are great profits in these stocks also.

A company like Citigroup isn't going bankrupt. They even posted a profit the last two months.

Market to market rules have also changed so companies like Citigroup can value their assets at what they are really worth.

We'll see this week when Citigroup's financials for the quarter come out.

Jay

Mar 29 05:39 PM

[zachw945:]

I think a similar investment strategy for bottom basement stocks has to be taken as one would for their investment portfolio in general. It's all about balance and diversity. For those investors still trying to create a balanced portfolio they need to have some stable (if such things still exist) stocks, some inexpensive stocks with potential to increase as well as other manner of stocks and investment vehicles. To just discount stocks because of their pricing wouldn't be doing justice to other forms of due diligence and would create a one sided portfolio. Just like pre-turmoil portfolio needs some risk so it is in our current situation as well.

Zach
Greedreviews.com- "Ranking and reviewing financial information sources from one investor to the next"

Mar 30 01:39 AM

[Roxieanne:]

Better to buy a stock that will increase in value at 50 cents than to buy a $50.00 stock that has peaked.

Having been through several major corrections, I find that one buys when nobody wants them----many of these under $5.00 stocks are just that.

While people ultimately lost $ in MCI-Worldcom when it crashed as MCI from $12.00 to about $1.00 a share----it was a buy------in the 1970's. Anybody who read Popular Science and had the guts to buy did well-----as Popular Science was where the technical info was about the telephone monopoly that was about to be broken up.

In addition to saying that cheap stocks are not always bargains as the author writes--------higher priced stocks may be overpriced and also not bargains.

Exercise your due diligence-----

Mar 30 02:26 AM

[expat in China:]

wow Tough bunch of traders,

I invest and do not want to own stocks that have droped 90% and get out fast as possible when they drop 15 to 20%. The risk is to high and I dont want that kind of reward if it survives from the bottom.

Once you have some wealth there is no reason to risk it when a 10% gain is enough to buy a home. For me like many managers we dont want to buy at the bottom and we dont want to sell at the top.

As you can imagine I am on the side lines and waiting and yes it could be some time before I buy anything.

My thought from another blog

"Shortly I will remove my cash from my big bank!

Please no one else do this because I do not want a run on the bank and them to be short of money before I move mine to a safe haven say Canada where banks are regulated.

Yes I am taking SHORT position they are scary, in debt and deserve it! Any rally is speculation caused by manipulation and not based on real recovery signs.

Sure the market will show a rally ahead of recovery but the recovery is not until 2011 and that will be a short one. The unemployment rate will grow larger for this year and next to 50 million, world wide? Who’s buying anything?

The debt driving programs will this year high light the lack of CHANGE in the USA and the real change in international sentiment towards our practices and our plans. G20 meeting will be laud one and will be reported quietly!"

Mar 30 03:10 AM

[Fighting Yoda:]

Stocks fall for a reason, investors sell them for a reason. A stock is worth what it is today and what it is likely to be tomorrow (whatever time frame), and not what it was yesterday. Just because you bought it at a higher price and not want to realize the loss, may not make the stock price go up. It is always wise to sell stocks that are not doing well – you would have done very well booking your losses on Citi, or BofA, etc ,rather than holding on to them

As regards $5, $10 stocks – history has it that they rarely recover, and most of the money is lost by the bottom fishers. Most importantly institutions and pension funds are not allowed to own (by their own charters) stocks less than $10 or $5. If the biggest buyers will not buy a stock – which way will it go but down.

Mar 31 12:40 AM

[mrmillergd:]

You must also consider "cheap" is just another step on the road to
"worthless."

Mar 31 07:49 AM

[Matt Miller:]

Didn't Peter Lynch recommend "Buy and Hold" ... How's that working out for you now Petey?

Apr 05 09:51 PM