Don't be fooled into thinking you are getting a bargain simply because the stock you are buying is down significantly. It makes no difference where a stock has been, it only matters where it's going.
As far as I can see the deck is stacked against most of these stocks. The marketplace is a highly competitive and an ever changing cut throat environment. Many more companies fail than succeed. You have to do nearly everything right to be a success while only one wrong move can send you to the poor house.
Many market participants refer to these types of stocks as value trades or traps. A value trap is a stock that appears to be a bargain based on fundamentals or the fact it is down significantly but has no future catalyst for recovery.
The stock traps investors when they buy into the company at low prices and the stock never improves. Sector, industry or company specific headwinds may be so strong and prevalent the company may never recover. Headwinds can be in the form of increased competition, product obsolescence, bad management, increased raw materials costs or a myriad of other factors.
A value trade is a stock that is down so low it's market capitalization is less than it's net asset value. The stock is often down for arbitrary reasons. Furthermore, the company must have the potential to rise again based on some type of future catalyst.
In the following sections we will perform a review of the fundamental and technical state of each company. Additionally, we will determine what headwinds or catalysts for growth may exist based on sector, industry or company specific developments. The following table depicts summary statistics and Friday's performance for the stocks.
Alcatel-Lucent, S.A. (ALU)
ALU is trading well below its consensus estimates and its 52 week high. The company is trading 70% below its 52 week high and has 71% upside potential based on the analysts' mean target price of $1.98 for the company. ALU was trading Friday for $1.16, up almost 4% for the day.
Fundamentally, ALU has some positives. EPS for next year is expected to rise by 64%. ALU is trading for approximately one half of book value and has a PEG ratio of .73. On the negative side, the company's sales are down 12% quarter over quarter. The company has a meager net profit margin of 3%; an ROE of only 2% and EPS is dropping drastically quarter over quarter.
Technically, ALU may have turned the corner. All the major moving averages are sloping downward, but the stock has rallied back close to the 20 day sma. The company recently climbed over 10% off it's 52 week low of 99 cents. The company is posting higher highs and higher lows for the past few days. The stock needs to continue its upward thrust and breach the 20 day sma to confirm the uptend.
One major headwind for the company is Infonetics forecast that, in spite of growing 4G deployments, global mobile capital expenditures will be roughly flat from 2012 to 2016. One reason is AT&T (T) and Verizon (VZ) have been steadily reducing their capital expenditures to revenue ratio, even if growth is harmed. Furthermore, European carriers struggling with macro and debt woes have become 4G laggards. In the cross hairs, assuming data traffic doesn't force carriers to spend more, are infrastructure vendors such as Alcatel-Lucent.
On the other hand, according to an updated report from the Global mobile Suppliers Association, by the end of 2012, there will be 150 commercial LTE networks and ALU is well positioned to take advantage of this growth. Please review the following short excerpt from the report:
Around the world there are currently 280 carriers who are already working on launching an LTE network, while another 58 carriers are still in the process of researching and testing the technology before adoption. LTE networks have seen rapid growth around the world since 2009 when 2 networks were initially launched. That number quickly expanded over the next two years, to 17 in 2010 and 47 in 2011, before reaching the 89 networks across 45 countries today. The long-trusted partner of service providers, enterprises and governments around the world, Alcatel-Lucent is a leading innovator in the field of networking and communications technology, products and services. Alcatel-Lucent along with AuthenTec recently announced they have helped enable Portugal Telecom to deliver mobile video to Android and Apple smartphone and tablet users.
The risk reward ratio is favorable at this point, I can get behind ALU because they have a positive catalyst, have bounced off their lows and the fundamentals are improving. It is not a bowl of cherries, but when catching a stock at its inflection point it never is. I am going to start a position, but of course layer in to it.
Advanced Micro Devices, Inc. (AMD)
AMD is trading well below its consensus estimates and its 52 week high. The company is trading 51% below its 52 week high and has 41% potential upside based on the analysts' consensus mean target price of $5.75 for the company. AMD was trading Friday for $4.09, up 3% for the day.
Fundamentally, AMD has some positives. AMD trades for 8.44 times free cash flow. The company has a forward P/E of 9.51. EPS next year is expected to rise by 53.57%. Insider ownership is up 49% over the last six months. AMD's RSI is 30. On the other hand, sales and EOPS are down 10% and 40% quarter over quarter. ROE is negative 45.61% and the company sports a -10% net profit margin.
AMD shareholders have been whipsawed throughout 2012. The stock had an incredible run from $5 to $8.25 in the first quarter only to see the stock crate to below $5 in mid-July on a Sterne Agee downgrade. Currently, the 50 and 20 day smas are nose-diving. The stock chart looks bad.
Sterne Agee's Vijay Rakesh says Seagate's (STX) guidance for a 10% quarter over quarter hard drive shipment drop in a seasonally strong quarter is bad news for Intel (INTC) and AMD. Seagate and Western Digital (WDC) both expect the total market for hard drives to be flat to down in the third quarter indicating PC sales will be weak.
The last earnings report threw me into the bearish camp. This is a change in stance for me on AMD. I am putting AMD into the penalty box pending next quarter.
Nokia Corporation (NOK)
Nokia is trading well below its consensus estimates and its 52 week high. The company is trading 55% below its 52 week high and has 4% potential upside based on the analysts' mean target price of $2.46 for the company. Nokia was trading Friday for $2.37, up over 4% for the day.
Fundamentally, Nokia is struggling. The stock has negative quarter over quarter EPS and Sales growth of 283% and 18% respectively. The company has a net profit margin of -12.77%. The company has a dividend with a yield of 10.66%. The question is will it be suspended as the company continues to lose money.
InterDigital (IDCC) took off recently after a U.S. federal appeals court ruled in the company's favor in a long-running suit against Nokia related to InterDigital's 3G patents. By doing so, the court is reversing an ITC decision in Nokia's favor. The case has been remanded for further review. InterDigital has issued a PR praising the ruling. The company stated it will again ask the ITC to ban Nokia products using the W-CDMA 3G interface used by AT&T and T-Mobile. Furthermore, Goldman Sachs (GS) recently downgraded Nokia to Sell on competitive fears.
The stock has bounced in recent days. Even still, I don't see the light at the end of the tunnel for this stock. They have recently picked up some market share, but at what price? If you have to give the phone away to pick up market share the bottom line will surely suffer. Avoid this stock.
Research In Motion Limited (RIMM)
RIMM is trading well below its consensus estimates and its 52 week high. The company is trading 79% below its 52 week high and has 12% potential upside based on the analysts' mean target price of $7.83 for the company. RIMM was trading Friday for $6.99, up slightly for the day.
Fundamentally, RIMM is a mixed bag. The stock has negative quarter over quarter EPS and Sales growth of 175% and 42% respectively. The company is unprofitable, yet is selling for 38% of book value and EPS is expected to grow by 49% next year.
Technically, RIMM's stock is in trouble. It is in a strong downward trend channel with no signs of support. The 200 and 50 day smas are nose-diving.
RIMM's CEO Thorsten Heins stated, "We don't have the economy of scale to compete against the guys who crank out 60 handsets a year." As a result, Heins is interested in licensing BlackBerry 10. But can RIMM convince anyone to choose their OS over Android and Windows Phone? Heins' comments echo concerns about how Apple (AAPL) and Samsung's (SSNLF.PK) monopoly on smartphone profits is depriving rivals of needed resources. This statement from the CEO does not do much for my confidence in the company's ability to overcome its issues.
This is just another bad move by RIMM. RIMM's Blackberry is yesterday's news. The name Blackberry has a negative connotation at this point. The Blackberry is out of style. I don't see it returning to its market leadership position. RIMM could eventually stop being a going concern. Stay away from this stock.
Zynga, Inc. (ZNGA)
Zynga is trading well below its consensus estimates and its 52 week high. The company is trading 83% below its 52 week high and has 188% potential upside based on the analysts' mean target price of $7.84 for the company. Zynga was trading Friday for $2.72, up almost 1% for the day.
Fundamentally, Zynga has few positives. Year over year revenue is down. Zynga's net profit margin is -41.57%. That means they almost 1 out of every 2 dollars are lost.
Technically, the stock is the definition of a falling knife. The angle of decent is frightening. The stock has lost 50% of its value in the last month. Now, more bad news is being piled on.
Electronic Arts (EA) is suing Zynga for copyright infringement. EA claims Zynga's The Ville, which has recently seen traffic take off, is a rip-off of The Sims Social. More than a few observers noticed the similarities between the games when The Ville was introduced. Zynga has often been accused of copying the games of rivals.
Zynga can't seem to catch a break. They need diversify from Facebook (FB). But that will cost money. I have a Facebook account but never play the games and can't see why anyone would pay for imaginary farm supplies in the current macro environment. This stock was overpriced from the start. I posit some people see this as an opportunity because of the huge drop. In this case, perception is not reality. Stay away.
The Bottom Line
These five companies are all down substantially from their 52 week highs. I posit it is for good reason. Nonetheless, some investors see these stocks as buying opportunities. I spend a majority of my time searching for value in beaten down stocks. After many years of investing I have found that often stocks get walloped for good reason. Sometimes highly correlated market all stocks go down due to macro-economic concerns. That may explain part of why these stocks have declined, but not a majority of the downward movement.
Nevertheless, you will never find a buying opportunity that does not have some type of down side risk. You must analyze the situation as a whole and decide if the reward is worth the risk. Often, avoiding these stocks until they prove themselves is the best practice. Wait to see positive comments from management and corresponding positive developments in the fundamental and technical status of the stock. You may miss the first 5% 0- 10% of the move, nevertheless, your risk/reward ratio will improve dramatically.
Use this information as a starting point for your own due diligence and research methods before determining whether or not to buy or sell a security. If you choose to start a position in any stock, I suggest layering in 10% at a time on a weekly basis to reduce risk and setting a 5% trailing stop loss order to minimize losses further if you wish.