Change. It can be good or bad, wanted or unwanted but there's one universal truth about change - it's inevitable. There's another constant about change as well; people tend to resist it.
Investors are perhaps even more resistant to change than the average person. We've trained ourselves to keep a long term investment philosophy and resist temptations when the market waxes and wanes throughout the course of the business cycle. As such, when real change occurs that should prompt us to alter our strategy, we often tend to ignore it - generally to our own detriment.
Publicly traded companies are dynamic, ever-changing entities, but they can maintain a positive or negative outlook for many years. Take Google (NASDAQ:GOOGL) for example. Certainly the company has changed and evolved far beyond just an internet search company and yet the stock has almost always been held in a positive light with increasing growth expectations every year. Since the stock debuted in 2004, it has increased in value to 12 times it's original price which shows that trends and momentum, once a clear direction is established, are not easily knocked off course.
Investors that short a stock don't take the position arbitrarily. A stock must show some kind of sign that it's moving backwards, not forwards, whether it be because of falling earnings, poor management, being noncompetitive, or other similar reasons. A stock with a heavy short ratio is often a red flag that something is wrong and so much so that other short-sellers have jumped on board as well.
In some cases though, the short-sellers are wrong. They may be holding a position simply because it's what they're used to or because they haven't looked at what's changed about the underlying company. Investors with a sharp eye for value can often profit by taking a step back and looking at the stock with a holistic approach.
GenCorp (GY) is a good example of overlooked potential. The $1 billion aerospace and defense company has a short float of nearly 28% and it's not without some reasonable basis. The rocket engine company has seen profits evaporate lately on a rising cost of goods sold and free cash flow fell into the negative on shrinking operating margins. Furthermore, insiders have sold off around 5% of their shares, so short-sellers feel as if they are in good company.
However, it seems as if no one is looking at the company's potential. Increased spending on government programs surrounding space launch rockets could quickly turn this stock around. Total funded backlog is $2 billion with another $1 billion unfunded and awaiting Congressional approval. Considering that sales in the last year were $1.5 billion, that means GenCorp has about 2 years of revenue already wrapped up.
GenCorp's long term EPS growth expectations are at 20% and the stock trades at a bargain at less than 13 times earnings giving it a PEG ratio of 0.64. Quarterly revenue growth year-over-year is 40% and EPS growth next year is expected to be over 141%. Looking at how the stock has performed given it's strong short float, it's been resilient trading nearly flat YTD.
Risks to consider: The heavy short interest in the stock could weigh down any positive movements making this stock a long-term holding. In addition, further revenue decreases or drop in free cash flow could be a sign of weakness in management.
Actions to take: The long term potential of this stock makes it an ideal value holding with a price target of $25 - a potential pop of about 35%.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.