By David Sterman
Barring a year-end shocker, 2010 will go down as a good year for stocks. The S&P 500 is up more than 10% this year, and roughly 75% of stocks in the index are in the black in 2010. Of course, the other 25% would like to get past 2010, especially those that have been hit hard.
I went rummaging through the dustbin of S&P 500 losers and have found a few intriguing rebound candidates for 2011.
H&R Block (HRB)
The price-to-earnings (P/E) ratio on this tax prep firm really gets your attention. But few would argue for a higher earnings multiple at the moment. With unemployment at high levels, demand for the company's software and services are at a multi-year low.
Well, it may be a no-growth business right now, but free cash flow remains quite impressive. H&R Block has generated a cumulative $1.0 billion in free cash flow during the past two years. While business slumps and shares trade at levels last seen in 2002, management has decided to use some of that cash flow for ongoing stock buybacks. The company's share count has fallen by 10% in the past year, and management expects to take another chunk of the share count out of the public's hands in 2011. And while investors wait, they can also focus on the company's 4.6% dividend yield.
Will results rebound in 2011? Perhaps, but it will likely be a few years before improving employment trends enable H&R Block to post meaningful growth again. In the interim, the shrinking share count should set the stage for eventually higher per share profits. And it's unlikely that business will slump further, so that miniscule P/E ratio likely provides solid downside to the stock. If you're looking for long-term appreciation and a healthy dividend, H&R Block is emerging as a solid discounted play.
Diamond Offshore (DO)
One notable event stood out as the black-eye of 2010: the Gulf oil spill, which along with BP (BP), took down shares of Diamond Offshore, an operator of 46 offshore rigs for clients on several continents. Diamond is the country's second-largest provider of offshore drilling services, by market value. The company's shares plunged from $100 at the beginning of the year to around $60 by June, and they've been stuck there ever since.
The Gulf oil spill surely hurt. Sales are on track to fall -8% in 2010, while profits are off by a third. And few expect a sharp snapback in 2011, as drilling in the Gulf remains below previous levels while the industry settles on new safety standards. This business is all about supply and demand. With weak rental demand for these ultra-expensive rigs, asking prices are off sharply. The industry must now wait for demand to catch up with the supply of rigs, at which time daily lease rates should rebound.
More than likely, gulf drilling activity will only slowly rebound during the course of 2011, setting the stage for much improved results in 2012. As investors look ahead and anticipate that rebound, and a jump back in earnings per share (EPS) toward the $10 mark in 2012, shares should make up some of the lost ground from 2010.
All the companies on this list sold off for good reason. But SUPERVALU, Office Depot, Diamond Offshore and Office depot sill look poised for better days ahead. Near-term results could still be uninspiring, but incremental improvements should bring some of these deep value names back onto investors' radars in 2011.
Disclosure: No positions