My favorite investments are special situation stocks. Not only do they generally trade at a low correlation to other market assets, it is also easier to consider the upside and downside potential because the variables are relatively defined.
Here is a list of five special situation stocks that investors should pay close attention to. Each stock offers a significant potential for upside, and it allows investors to diversify away from stocks that are meaningfully exposed to the macro economics factors dominating the U.S. and European markets.
Sino-Forest Corp (SNOFF.PK)
The Chinese forestry company ran into the same skepticism facing other Chinese based companies but Sino-Forest was cut down to size in a very brief and public manner. Short selling firm Muddy Waters, issued a bearish report about the company claiming that it was a fraud worth less than $1.00 per share. In the ensuing days, the stock fell from around $20 to around $2. In what seemed like a validation of the report, Paulson & Co sold its sizeable stake in the company around the time the report was issued.
Since then, shares have regained some lost ground, rallying to $8 on news that smart money investors are taking advantage of the recent price drop to acquire shares. Early this month, Wellington Management disclosed an 11.5% stake in SNOFF.PK. More recently, Mandolin Fund disclosed a 15% stake. In addition to Davis Funds' sizeable position, this collection of investors have driven up the stock price and given other investors the confidence to buy shares. While the company is still well below its previous levels, the company is clearly a special situation for investors, with plenty of potential upside for bulls or bears.
Genworth Financial (GNW)
The insurance company has taken its share of hits during the financial crisis, and the stock continues to trade at depressed valuation levels because of its exposure to the U.S. mortgage industry. The company trades at a trailing P/E of 82.80, a forward P/E of 5.14 and a price/book of 0.27. During its most recent quarter, the company reported a net loss of $96 million. It was forced to increase its reserves for the U.S. mortgage insurance segment by $300 million.
The insurer could be primed for upside, though it seeks to break apart the company because the market 'dramatically undervalues' the stock. While there is no doubt that its mortgage operations remain weak, the company's other segments have held their own. The Retirement and Protection segment generated $149 million in operating income, a sharp jump from the year ago operating income of $114 million. The International segment remained stable with operating income of $107 million.
E*Trade Financial Corp (ETFC)
The online discount brokerage has effectively been in play since the exposure to the U.S. mortgage market crippled the company. Chicago based hedge fund Citadel LLC is now pushing for change. The fund owns a 9.8% stake in the brokerage and they have a bit more credibility because they have been shareholders for some time. Citadel LLC is calling on the broker to create a Special Committee of the Board to review strategic alternatives, remove the staggered Board approach and replace Michael Parks and Donna Weaver with independent directors.
At this point, ETFC's most viable option may be to sell its brokerage operations to TD Ameritrade (AMTD) and partition off the company's unwanted mortgage and balance sheet exposure to a bank or financial specialty firm. Investors should pay close attention to this stock. AMTD would surely like to acquire ETFC's brokerage assets, but the key to the transaction will be finding a partner for the residual components.
Motorola Mobility (MMI)
The recently spun-off mobile device and home networking company is facing severe headwinds because of strong competitive pressure in its core business.
The obvious problem is Apple's (AAPL) dominance, but MMI is also struggling to compete in the Android marketplace. Despite the problems, activist shareholder Carl Icahn sees value in the stock. Icahn speculates that Motorola Mobility's patent portfolio for mobile devices is larger than the Nortel portfolio that sold for $4.5 billion to a consortium of bidders. If this is true, the company could be an attractive sum-of-the-parts valuation story. Between the patent portfolio value and about $3 billion of cash and investments, the stock could have 50% of more of upside.
Level 3 Communications (LVLT)
Level 3 is a smart money favorite, but the reasons may not be apparent just by looking at the trailing fundamentals. The company is set to merge with / acquire Global Crossing (GLBC). While we generally like to fade management excitement over potential post-merger operational synergies, we are excited about this combination. With $300 million in annual synergies, the merger offers significant value to shareholders. But there is much more to it if the merger can improve LVLT's pricing power. This could be a powerful trend as the company continues to benefit from the increasing growth of data usage and the increasing cost of bandwidth.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SNOFF.PK, GNW, ETFC, MMI, LVLT, GLBC over the next 72 hours.
