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To create the list below we began with a universe of stocks that are being targeted by short sellers, with short floats above 10%, and that are also technically oversold (with RSI(14) below 40). About 65 stocks met the criteria.

We then looked for a possible fundamental catalyst, which might have lead to the negative sentiment.

We moved to looking at growth in quarterly revenue slower than growth in quarterly inventory year-over-year. We also looked for companies with quarterly inventory increasing as a percent of current assets.

When revenue is growing slower than inventory, it may indicate that the company is having trouble selling its inventory - although this might just indicate inventory building or a change in sales policies.

Do institutions think it might be an opportunity to buy stocks at cheap valuations? We finally screened for those stocks with bullish sentiment from institutional investors, with significant net institutional purchases over the last quarter representing at least 5% of share float. This indicates that institutional investors such as hedge fund managers and mutual fund managers expect these names to outperform into the future.

We were left with 3 companies on our list.

The List

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned below. Analyst ratings sourced from Zacks Investment Research.

Do you think hedge funds are calling it right on these names? Use this list as a starting point for your own analysis.

1. AK Steel Holding Corporation (AKS): Produces flat-rolled carbon, stainless, and electrical steels, and tubular products primarily in the United States and internationally.

  • Market cap at $472.86M, most recent closing price at $3.31.
  • Net institutional purchases in the current quarter at 23.1M shares, which represents about 17.2% of the company's float of 134.32M shares. The 2 top holders of the stock are State Street Corporation, and The Vanguard Group.
  • Revenue grew by -5.71% during the most recent quarter ($1,423.1M vs. $1,509.2M y/y). Inventory grew by 45.5% during the same time period ($609.2M vs. $418.7M y/y). Inventory, as a percentage of current assets, increased from 32.85% to 42.23% during the most recent quarter (comparing 3 months ending 2012-12-31 to 3 months ending 2011-12-31).
  • Float short at 28%, and RSI (14) at 29.
  • AKS has returned -15.99% since 2/22/13, and is one of the worst performing stocks in its industry. The stock is falling behind companies like Nucor Corporation (NUE) and Tenaris SA (TS), which returned 2.15% and -2.85% during the same time period.

2. Kronos Worldwide Inc. (KRO): Engages in the production and marketing of titanium dioxide pigments in North America and Europe.

  • Market cap at $1.91B, most recent closing price at $15.91.
  • Net institutional purchases in the current quarter at 1.9M shares, which represents about 9.57% of the company's float of 19.85M shares. The 2 top holders of the stock are American International Group, and LSV Asset Management.
  • Revenue grew by -13.7% during the most recent quarter ($472.9M vs. $548M y/y). Inventory grew by 79.45% during the same time period ($604.2M vs. $336.7M y/y). Inventory, as a percentage of current assets, increased from 40.06% to 57.29% during the most recent quarter (comparing 3 months ending 2012-09-30 to 3 months ending 2011-09-30).
  • Float short at 22%, and RSI (14) at 34.
  • KRO has returned -6.96% since 2/22/13, and is one of the worst performing stocks in its industry. The stock is falling behind companies like LyondellBasell Industries NV (LYB) and The Sherwin-Williams Company (SHW), which returned 8.73% and 6.54% during the same time period.

3. Trina Solar Limited (TSL): Designs, develops, manufactures, and sells photovoltaic (PV) modules worldwide.

  • Market cap at $329.55M, most recent closing price at $3.88.
  • Net institutional purchases in the current quarter at 6.8M shares, which represents about 11.% of the company's float of 61.80M shares. The 2 top holders of the stock are Templeton Foreign Fund A, and JHFunds2 International Value.
  • Revenue grew by -38.17% during the most recent quarter ($297.97M vs. $481.9M y/y). Inventory grew by 9.5% during the same time period ($367.13M vs. $335.27M y/y). Inventory, as a percentage of current assets, increased from 18.35% to 21.14% during the most recent quarter (comparing 3 months ending 2012-09-30 to 3 months ending 2011-09-30).
  • Float short at 24%, and RSI (14) at 38.
  • TSL has returned -16.92% since 2/22/13, and is one of the worst performing stocks in its industry. The stock is falling behind companies like NVIDIA Corporation (NVDA) and Linear Technology Corp. (LLTC), which returned 0.32% and -1.35% during the same time period.

*Institutional data sourced from Fidelity, all other data sourced from Finviz

Source: Hedge Funds Are Buying 3 Oversold & Highly Shorted Stocks With Troubling Inventory Turnover