Screening 2010 Losers for 2011 Opportunities

by: Alan Brochstein, CFA

If you are a momentum investor, the kind of investor who likes to pile on to winners with hope of positive trends continuing, this article probably isn't for you. Today, I am looking at stocks that have made their investors unhappy lately, wondering if some of them might be bargains. The fourth quarter can present all sorts of opportunities, as the combined effects of tax-loss harvesting, window-dressing and deleveraging by hedge-funds conspire to shift the odds in favor of mean-reversion strategies. With that in mind, I screened the S&P 500 with the following parameters:

  • Down YTD
  • Up over the past two years
  • Net Debt to Capital < 50%
  • Sales up over the past four quarters from a year ago
  • Positive EPS past year and next year

124 names are down in 2010, almost 1/4 of the market. Within this group, some are down because fundamentals are deteriorating. Others are down because they went up too much previously and are "getting back on track". In order to avoid the former, but hopefully identify the latter, we kicked out all the stocks that aren't up from 12/08. Next, I wanted to kick out heavily indebted companies. The requirement that sales are not in decline is another attempt to avoid deteriorating fundamental situations, as is the requirement of profitability. With these parameters, we were able to eliminate about 57% of the losers. Here are the 53 that made the cut:

2010 sp5 losers
I maintain a 100-stock watchlist, and only 5 of these names intersect the companies I follow most closely (in bold on the tickers above). With that said, I am familiar with many of these companies. What's nice about the results is that 9 of the 10 economic sectors (all but Telecom Services) have at least a single representative. Which of the companies that made the cut look interesting to me? Let's take the list by sector.

Looking at the Consumer Discretionary stocks, Staples (NASDAQ:SPLS) is the best in class of an industry that has certainly been hit by the recession. With likely consolidation in the sector as well as a reasonable valuation considering how depressed margins are, I think this one merits further attention. I will pass on Gamestop (NYSE:GME) - its best days appear behind it. Whirlpool (NYSE:WHR), which was profiled in Barron's this weekend, strikes me as an excellent company in terms of management but with some accounting question-marks. It is very inexpensive on the surface.

Among the Consumer Staples companies, Kimberly-Clark (NYSE:KMB) and Colgate (NYSE:CL) have been hurt by private label competition. Perhaps the continued improvement in consumer confidence will mitigate this trend. I don't know the Archer-Daniels (NYSE:ADM) story.

Looking at the 4 Energy stocks, one of the big themes of 2010 emerges: Gas Shale disappointment. I have addressed this theme throughout the year, most recently sharing my interest in the sector after having avoided it. We own Comstock Resources (NYSE:CRK) in the Top 20 Model Portfolio, as I am somewhat optimistic that gas prices have bottomed. More importantly, demand should fuel strong unit growth as costs continue to decline. The sector has new-found discipline when it comes to capital allocation. Of the 4 S&P 500 companies on our list, Southwestern (NYSE:SWN) and EOG Resources (NYSE:EOG) strike me as very well-run, while Chesapeake Energy (NYSE:CHK) is a name that I would avoid.

I don't have a deep knowledge of any of the Financials that made the cut, but JP Morgan Chase (NYSE:JPM) strikes me as a tremendous value. Earnings estimates for 2011 have been stable since this summer. CME Group (NASDAQ:CME) was a monster in 2009 and ended up retracing about half of the gains off of the late 2008 lows. To me, it looks back on track.

The Healthcare sector is littered with good companies that have faced hard times. We own Johnson & Johnson (NYSE:JNJ) in the Conservative Growth/Balanced Model Portfolio, and I think that it offers 37% price appreciation from this level as the PE multiple expands from a depressed 13X. In fact, we just added to the position on Friday. I want to call out Intuitive Surgical (NASDAQ:ISRG) as well, as I definitely have my eye on this one. This one was a rocket in 2009 and into April but has retreated over the past two quarters as the company has seen growth come in a bit slower than analysts had expected and margin expansion has become challenging. Nevertheless, this monopoly company that I consider one of the best-run companies looks like a great entry to me. I like the rest of the names except for the two Big Pharma companies.

Industrials, not surprisingly, aren't well represented. L-3 (NYSE:LLL) is one of many defense-oriented companies having a tough time. It trades at an all-time low of 6X EV/EBITDA. Quanta Services (NYSE:PWR) is right here in Houston, but I don't know it well .

Technology, not surprisingly, is very well represented. Some of these companies seem fundamentally challenged, like Dell (NASDAQ:DELL) and Micron (NASDAQ:MU), but there also appear to be some potential opportunities. I have been surprised that Hewlett-Packard (NYSE:HPQ) has remained in the doldrums since its CEO left and believe that Wall Street is concluding incorrectly that the new CEO is an expensive dud. While none of these names are "cloud plays", several of the companies would appear to have at least reasonable growth ahead. Cisco Systems (NASDAQ:CSCO) is extremely oversold after the disappointing Q1 conference call and looks like one of the best large-cap bargains in the market. I just added it to the Top 20 after having started a position this summer in the Conservative Growth/Balanced Model. I used to follow Jabil Circuit (NYSE:JBL) closely. I find the whole EMS industry to be priced inexplicably low in terms of valuations. I think its challenging to hone in on what's "best" in terms of mean reversion, but I think that investors will find it well worth their time to consider some of these names.

The Materials companies include two steel metals names and two paper names. I don't have much familiarity, but I do watch Alcoa (NYSE:AA) because it is so leveraged to one of my favorite themes, commercial aerospace.

Finally, the sole Utility, Sempra Energy (NYSE:SRE) is one that one of my clients owns, so I am familiar with the opportunity there. The company exited a JV, resulting in lowered EPS and then repurchased stock. The earnings estimates for 2011 show 15% growth after a 24% projected decline in 2010. Investors will likely appreciate the steadier growth from the regulated portions of their business. For now, the 3% dividend isn't exactly enticing. Over time, though, I expect the company will raise its dividend.

So, it looks like many of these companies are worth investigating further. We know that last year's losers are often next year's losers as well, so hopefully the screen has helped reduce our exposure to companies locked into bad trends. The names that stand out to me for further consideration would be SPLS, JPM, ISRG, JNJ, CSCO and HPQ.

Disclosure: Long CRK, JNJ and CSCO in models at Invest By Model.