There are many pundits who maintain the individual investor is at a disadvantage against well capitalized fund managers. I disagree with this thinking, I believe the individual investor has two distinct advantages.
1 - The individual investor does not have to worry about outperforming the competition or the S&P 500.
2 - The individual investor does not have a "report card" sent to investors at the end of the year detailing every stock he/she owns.
A fund manager keeps his/her job by beating the averages and/or the competition and bringing in new money. If you underperform and money starts to leave the fund, chances are you will be out of a job. As such, many fund managers follow the herd, owning the same stocks as everyone else keeps them from underperforming the competition. If XYZ is the hot stock, they will be in that stock too. This also means that when preparing the year end report to shareholders, fund managers will engage in "window dressing". This a term used to describe buying all the hot stocks and selling any big losers before the end of the year so it appears to your investors that you are a very smart manager and own all the years winners and none of the big losers. This year end selling can lead to opportunity for individual investors. As fund managers unload the years losers, some, not all, companies can get very oversold.
Let's take a look at a couple examples.
The first example is Bank of America (BAC). In the second half of 2011, BAC started coming under selling pressure which accelerated into the end of the year. However, from the opening bell ushering in 2012, BAC started to gain much of what it lost back, as fund managers started to add BAC back into their portfolios. Below, is a chart showing the price action on BAC in late 2011 and early 2012.
As you can see in the chart above, selling pressure increased as the year was drawing to a close. However, buyers quickly returned when the new year began. Fund managers didn't want to be seen owning BAC as 2011 ended, but they also knew BAC had value and quickly got back into the stock when the new year began.
Bank of America was still a large bank with numerous branches and customers. They were still one of the largest holders of mortgages in the country and had a large deposit base. Was the bank having issues? Yes it was. However, it was not going to go out of business, Warren Buffett and the U.S. government had seen to that. At the time, BAC's market cap was less than the cash it had on the books. An astute investor could have determined BAC was being sold indiscriminately.
Our second example is Hewlett Packard (HPQ). In the second half of 2012 HPQ came under pressure as a series of CEO upheavals and product miscalculations had badly damaged HPQ's reputation and stock price. The chart below shows the price action in HPQ as 2012 drew to a close and 2013 began.
Hewlett Packard was having issues, but it was still a leading printer and computer company. HPQ had also recently hired a respected CEO in Meg Whitman who had begun her transformation of the company. HPQ's stock price had opened 2012 selling at approximately $26.00 and then declined about 20% down to $21.20 in June. From there the price dropped almost an additional 50% to $11.55. HPQ was a formidable company with solid businesses that had fallen behind its rivals. However, when the stock price fell below book value in late 2012, despite the changes that were in motion, an investor again could have seen the selling in HPQ was overdone.
The Worst of 2012
Let's take a look at the ten worst performing stocks in the S&P 500 in 2012.
|Company||Price 12/31/12||Price 10/22/13|
|Apollo Group (APOL)||$20.92||$20.92|
Advanced Micro-Devices (AMD)
|Best Buy (BBY)||$11.85||$42.81|
|JC Penny (JCP)||$19.71||$6.42|
|Allegheny Technology (ATI)||$30.36||$32.04|
|Cliffs Natural Resources (CLF)||$38.57||$23.55|
|Pitney Bowes (PBI)||$10.64||$19.96|
|Electronic Arts (EA)||$14.52||$24.50|
As you can see in the chart above, of the ten worst performers in 2012, seven are now higher and one is unchanged. Only two of the ten worst performers continued to decline. I believe the chart above shows that value can sometimes be found from the worst performer list at the end of the year.
Best Buy has more than tripled since the close of 2012. Best Buy was thought to be a retailer in trouble, Amazon (AMZN) was taking sales away from BBY and Wal-Mart (WMT) was also expanding sales of electronics. However, management took action to update the stores, adding the Samsung store within a store concept, closing unprofitable stores and reducing inventory. Results have improved and the stock price has recovered. Best Buy stock price was approximately $17.00 in June, but fell all the way down to just over $11.00 at the close of the year. Keep in mind, Best Buy's co-founder Richard Schulze was trying to take the company private, originally offering $24.00 to $26.00 a share. A sell-off of 33% in a few months would seem over done.
Action Going Forward.
The thesis of this articles is that end of year fund window dressing and tax selling can provide opportunity. Normally, swimming in the worst performer waters is not a sound investment approach. Bad performers are usually bad due to bad business conditions. However, excessive and sometimes misguided end of year selling can provide an opportunity. The first step is to review the worst performers list. This would be a starting point, other stocks that have underperformed should also be researched.
The chart below shows the worst S&P 500 performers to date.
Note- List is as of 10/21/13
|Company||Current stock price||YTD Return|
|Newmont Mining (NEM)||$28.55||-38.6%|
|Cliffs Natural Resources||$24.06||-37.7%|
|Abercrombie & Fitch (ANF)||$34.45||-28.39%|
|Peabody Energy (BTU)||$19.07||-28.07%|
|Intuitive Surgical (ISRG)||$368.67||-23.89%|
Let's take a look at the list and see if we can pick a candidate or two for possible purchase if the stock gets oversold. Looking at the eight stocks above, we see three mining stocks, NEM, CLF, and BTU. For those stocks to have a quick rebound in price next year you would need a change in coal, iron ore and gold prices. If you believe that is going to happen, than those three stocks should be watched. Personally, I do not see a turnaround in pricing so those three are off my list. We also have two technology companies, TDC a data warehousing company and Broadcom a chip company. Both of these companies are down after missing second quarter earnings and issuing disappointing guidance. Neither stock is particularly cheap and both stocks are in rapidly growing business sectors. BRCM reported earnings after the close on Tuesday and beat estimates. Therefore, it is possible the stock could rally from here and not see selling pressure as the year winds down. Both stocks probably are worth watching, but I don't expect either to see heavy end of year selling as the tech sector has seen buying this year.
That leaves only three stocks, JCP, ANF and ISRG. I am eliminating ISRG because its price tag of well over $300.00 makes it difficult for most retail investors to take a nice position in and I don't expect to see huge selling into year end. So the two stocks I think could come under heavy selling as we approach the end of the year are JCP and ANF.
JCP is a retail institution in this country having been in business for over 100 years. It has over 1,000 stores in 49 states and also has an internet presence. As most people know, JCP hired Ron Johnson as CEO and his JCP makeover alienated the JCP's core customers and sales fell dramatically. Mr. Johnson has since left JCP and new management is trying to undo the damage he did. JCP also recently completed a secondary offering to improve its cash position.
JCP's most recent quarterly earnings report in August did have this statement that I found somewhat promising.
"Despite these challenges, comparable store sales for the quarter improved sequentially by 470 basis points when compared to the first quarter of fiscal 2013. In addition, sales results improved sequentially each month within the second quarter, a trend the Company expects to continue through the back half of the year."
That may not sound like much, but sales improving month over month is not a bad sign and if JCP management can continue the improvement in sales through the all important holiday season, JCP may not be dead just yet.
Make no mistake about it, JCP is in a tough place and turning things around will take some time. This is a hated stock as most everything I read about JCP is negative. The negativity makes it a perfect candidate for excessive end of year selling. The question is, what is the value of the company if it survives? Keep in mind JCP has quite a bit of prime real estate which has value of its own. What I intend to do is watch the stock price and volume charts while also watching the monthly sales report from JCP. If it appears JCP is going to survive, then $6.00 or less is a bargain price.
Abercrombie & Fitch is a teen clothing retailer operating 1,057 stores comprising 265 Abercrombie & Fitch stores, 144 Abercrombie kids stores, 478 Hollister Co. stores, and 20 Gilly Hicks stores in the United States, along with a small international presence.
ANF was once the hottest brand among teenagers, but has since seen sales slow. ANF's second quarter earnings report in August showed a large decline in profit and tepid guidance. However, management did state there were some bright spots.
" Despite the challenging environment, we are very pleased by strong growth in our direct-to-consumer business and continued strong growth in China. We have also made excellent progress on our profit improvement initiative during the quarter, and we now expect savings from this initiative to exceed $100 million annually."
ANF has gone through soft sales periods before with the stock price falling into the low to mid 30's four times over the last four years only to recover every time. Sales in Asia are growing and management has looked to cut costs. Teens will want clothes and ANF's prime locations in malls will be there to sell the clothes to them.
Unlike JCP, ANF is in no danger of going out of business. The stock currently sells for a P/E of 11, which is a very reasonable price level. Many apparel retailers have reported slow sales which has driven the price of many apparel retailers down. ANF is currently selling in a price range where it has fallen to previously and recovered. I believe ANF would be a huge bargain if end of year selling were to drive the price of ANF below $30.00.
As I have mentioned, stocks that have seen big declines are almost always companies with either short term or long term problems. I prefer to invest in companies with solid long term fundamentals. However, for a short term trade, I am willing to buy a stock if I believe it is mis-priced. End of year selling can provide bargains in companies that Ben Graham referred to as cigar butts. These are companies with issues, but have value above their current share price. As Graham stated, these are short term trades, not long term investments. In my opinion, any stock bought off a worst performer list should be a trade, not an investment.
We are in the second half of October, a lot can happen between now and the end of the year. There are no guarantees any of the stocks I have mentioned will see a dramatic fall in price. Nor, was the list I provided an all-inclusive list, there may be other companies that have a big sell-off as the year draws to a close. What I hoped to do was alert the reader to an area of possible investment. As we progress through November and December, keep your investor eye open for stocks that are being heavily sold. Fund managers may be dumping a stock that they will be perfectly happy to buy back when the new calendar year begins. The fund managers have to wait until their books close on 2013, you do not have to. If you see the right opportunity, buy the stock and let the funds manager's money push the stock higher in the new year.