Looking For Bargains On The Half-Off List

by: Alan Brochstein, CFA

As a Seeking Alpha contributor for over five years, I have learned that when I write about potential bargains among the laggards rather than the leaders, I generate a lot more interest among readers. To me, it makes a lot more sense to focus on good companies showing relative strength (like my "14 Quiet Breakouts" from last week) or companies that might be lagging but that don't have broken charts (let's call it short-term negative momentum). Really low price can signal problems more often than opportunities in my view.

Still, I have to admit to looking in the bargain bin, though I have found it more useful to do so in more illiquid names, as they are the ones that can often be overdone to the downside, affording good entries for those who are perhaps patient. It seems like most of the focus, though, is on larger, better known companies, whose large price declines seem to draw attention from those who think that the market has overdone it perhaps.

I am not sure if this is so out-of-the-ordinary, but 14 stocks in the S&P 500 are trading at less than half their peak value over the past year. This comes at a time when the overall market is up a modest 2%. In the table below, I share some data on all 14. I don't follow all of these companies - in fact, none of them are on my watchlist. So, caveat emptor. I won't be "recommending" any of them, but I hope I shed some light on the risks as well as perhaps which ones might merit more consideration. I might even convince you to shift your focus away from the 52-week low list! Here are the stocks, sorted by market cap (data provided by Baseline):

Click to enlarge

Before I explain my color-coding, there are a few themes going on here. First, four of the names are in Energy, all linked by the plunge in natural gas prices. Then, several are in telecommunications. The rest look to be unrelated to one another.

So, when looking at falling knives, I think it's important to understand that often the equity holders are at the back of the line if things don't go right. Of course, there is likely more upside potential if things do go well, as financial leverage can really magnify things. I have the traditional "net to debt capital" in the sixth column, and several of the companies have very little net debt - I have highlighted those below 10% in green and called out two with more than 50% in red.

Debt certainly has priority over equity when things go wrong, but sometimes there are liabilities that aren't debt but that can impact future cash flows. I have highlighted in red all the stocks that have total liabilities in excess of three times the current market value (and in green those with less than half). I highly recommend that you understand the nature of those liabilities. Take a company like Netflix (NASDAQ:NFLX), for instance. While it has cash in excess of debt, it has future obligations for content. If it can't meet its subscriber goals, future earnings will likely fall short of estimates as it incurs higher costs per subscriber for content. Chesapeake (NYSE:CHK) has a very complex balance sheet - I don't pretend to have studied it in depth. While the net debt to capital may look reasonable, the high amount of liabilities requires a thorough investigation. Juniper (NYSE:JNPR) is one where the balance sheet doesn't seem to present any analytical challenges.

Changing gears, price momentum is more of an art than a science. On the one hand, it can pay off to buy the exact low, at which point price momentum will be ugliest, but one never knows until afterwards. When looking at dogs, I like to have some sort of positive price momentum over the last month or quarter. In the table above, you can see that there isn't much. Coal stock Peabody (BTU) has worked back over the past month to match the market (the numbers are relative to the S&P 500 and not absolute). It's smaller rival too has shown similar behavior.

I highlighted companies in red that have little or no earnings - this can add to the likelihood of further sustained losses, especially when the balance sheet is poor, like Sprint (NYSE:S). I also have highlighted the stocks with little or no tangible book value in red (and those trading closer to their asset value in green). If I am looking at a falling knife, I want to have a sense that there might be an alternative path if things don't work out - some sort of intrinsic value. With that said, I have seen plenty of stocks fail to anchor at their tangible book value. Even on this list, a few, like Genworth (NYSE:GNW) and First Solar (NASDAQ:FSLR) trade so far below that it makes one question if there is any "there" there.

In addition to the level of earnings, the rate of change is important to me. If a stock is hammered because it slows from 25% to 10%, at least it is still growing. Most of these stocks are seeing negative EPS growth, which I have highlighted (when double-digit) in red. I also called out the ones growing double-digit in green. I also like to look at the earnings revisions - which way are the analysts taking estimates? Not surprisingly, they are chopping. That makes sense. In fact, if they were raising estimates but the stock was falling, it would make one suspicious. I have highlighted in red the double-digit decliners. The way I like to look at this information is to then try to see if perhaps the estimates have been cut too aggressively or to try to detect a slowing in the cuts. Again, more art than science.

Finally, I included the short-interest ratio. Only three names are very heavily shorted. It's no secret when a stock is heavily shorted. Again, no rules here, and a heavily-shorted stock can get squeezed, but I tend to think that when a stock has been hammered and the shorts stay there, it's probably not a good sign.

So, given all of this information, which stocks on this list (if any!) do I think might merit further attention? Of the 14, I am going to go with 5 (no special order):

  • Juniper
  • Peabody
  • Newfield Exploration (NYSE:NFX)
  • JDS Uniphase (JDSU)
  • Devry (NYSE:DV)

Again, these aren't "recommendations" - I haven't thoroughly explored any of them. Let me share my thinking, though.

On JNPR, I think that the stock was hammered when it became apparent that they weren't cleaning Cisco's (NASDAQ:CSCO) clock but rather there was a slowdown. (Note: I prefer CSCO, as it is in one or more model portfolios I manage at Invest By Model).I think that this company is well-managed and certainly has a strong balance sheet. The valuation at 8.5X EV/EBITDA is near the lows for the past five years, and analysts (eternal optimists that they are) expect a big recovery in earnings in 2013 (+37%).

I really don't follow the coal industry too closely, but I think that BTU looks better than Alpha (ANR) based on the metrics in the table and my understanding regarding some integration risk from the poorly timed acquisition ANR did last year. For the stock to work, most likely natural gas will need to rise.

Speaking of gas, NFX sure looks better than CHK. Why take all of that headline risk? It's certainly not the same bet, as it has transitioned towards oil, with a lot of the growth coming from international (Malaysia). Like I said, I don't follow it closely. I do like the three E&P names on my watchlist.

JDSU has pulled back a lot, but it remains in an uptrend since bottoming out in 2008 and has a nice base of support not too far below. I honestly have never looked at this company. I remember going to the H&Q Technology Conference in 2000, when the stock traded at something like 100X on P/S basis. It now trades at 15X on a P/E basis. I wonder how many others have never looked at it just because it is a shadow of its former self.

Last up is DV, which may be one of the best houses in a bad neighborhood. The industry is weighed down by funding issues and concerns of fraud. DV has big insider ownership - 4.4% at the time of the proxy, and this excludes an 8.6% holding of co-founder Dennis Keller. Their recent 10-Q highlights a focus on Medical and Healthcare, and they also have expanded into International, K-12 and Professional Education, but the largest exposure remains in Business, Technology and Management. The 10-Q also denotes 73% reliance on Title IV funding (federal), so it's certainly beholden to government funding.

So, hopefully this has been helpful for any of you bargain-hunters out there. Again, I think that trying to time purchases of broken stocks is quite challenging and prefer to focus on companies with better charts and better fundamentals.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: As mentioned above, CSCO is held in one or more model portfolios at InvestByModel.com