Investors seeking bargain stocks have to learn to analyze turnaround stories. These are businesses that have to change their strategies and products to survive.
The following companies were screened to find companies which are producing net losses but have histories of yielding dividends. These turnaround stocks can prove attractive if they are discounted to compensate investors for the risks of a shifting strategy and if management has a long-standing commitment to dividend payments.
Diversified Computer Systems
In addition to net losses over the past 12 months, there are news stories which have helped drop the valuations of these companies to make them cheap. Some of these companies are compelling bargains while others might be cheap for a reason.
Japanese or Global Firms?
Panasonic and Sony are Japanese stocks. The Japanese investing public has grown fearful of stock market crashes and refuses to chase stock prices. This behavior results in chronically low price multiples for Japanese stocks. Oddly, this may be an opportunity for global investors. Yes, demographics and government debt/GDP ratios are terrible for Japan. These stocks derive revenues (and hopefully in the future, earnings) across the globe, not just Japan. Foreign investors interested in these stocks can buy a global multinational on the cheap simply because its headquarters is located in Japan. The components and supplies for these companies are sourced from around the world, and their customers hail from around the world. Outside of legal or property right issues, Japan's macroeconomic outlook does not preclude investment in Japanese-domiciled stocks any more than it would for General Motors (GM) or Apple (AAPL). Sophisticated modern investors should realize that the world is flat. Investors who fear the high value of the Yen and a potential reversal in exchange rates can hedge their currency exposure by buying put options on the Yen.
Sony has been plagued by sales problems, most notably its TV division. The slow global economy does not help: Sony has cut its yearly target of TV sales from 17.5 million to 15.5 million units. Sony has lost about $8.89 billion since early 2004. Nevertheless, Sony remains hopeful that it can turn its luck around.
For one, Sony is still pushing through with its over-$600 million investment in Olympus and is selling its chemical products division and other non-core businesses in order to cough up some cash. Sony hopes to recover from a string of losses through reorganization of business holdings. This could be difficult amid strong competition from giants Samsung and LG Electronics.
TV will be part of the turnaround: according to its CEO, Sony will release a shorter list of fewer models, and hopes to recoup losses by early 2014. Sony's CEO promised to keep the TV business running, and even talked about the new 84-inch Sony Bravia, which will soon retail at $21,500 in Japan. The new Bravia is based on 4K technology, which can present higher-resolution images much better than current HD TV models. Sony is hopeful that large TV sets will be in much greater demand in overseas markets, and the promise of high-resolution images can help pull buyers in.
Hewlett-Packard and Nokia
Legendary short-seller Jim Chanos made news when he assessed Hewlett-Packard as a short candidate. Companies like Nokia and Hewlett-Packard are in trouble in the wake of an Apple-led movement from personal computers and regular cell phones to smartphones and tablets. Mr. Chanos is concerned that Hewlett-Packard will refuse to age gracefully and instead will acquire other companies in desperate attempts to acquire lost market share.
Are Nokia and Hewlett-Packard cash sinkholes? Mr. Chanos warned that R&D spending, which is immediately expensed according to US GAAP (Generally Accepted Accounting Principles), is largely capitalized in an acquisition. This salient point would allow firms which engage in acquisitions to keep earnings free from R&D expense. Their peers that internally develop their brands and technology would be at a disadvantage in their financial statements since their earnings would be lower after expensing research and development costs. (Apple, for example, does not have an explicit acquisitions cash flow item.)
This means that investors should pay careful attention to acquisition expenditures and free cash flow adjusted for acquisition payments. Net acquisition cash flows were subtracted from free cash flow below:
Free Cash Flow
Acquisition Cash Flow, Net
Adjusted Free Cash Flow
(Values millions of dollars for all firms except Nokia whose values are in millions of Euros.)
After for adjusting for R&D cash flows both Hewlett-Packard and Nokia have had years where they have seen adjusted cash outflows. You would never know this if you stuck with the traditional exclusion of acquisition costs from free cash flow calculations. Mr. Chanos may be on to something!
Turnaround Plays: Don't Hold Your Breath
There are no guarantees that management interests will align with shareholder interests. The lure of spending on sexy capital projects can overshadow shareholders begging for dividend payments. In addition, management may cling to terminally-ill capital projects rather than sell non-core assets and underperforming segments to outside bidders.
Fortunately, a history of dividend payments helps screen these turnaround candidates for their commitment to shareholder interests. All of these companies on this list pass this screen.
That being said, Hewlett-Packard has a particularly nasty history of R&D-adjusted capital expenditures. Nokia isn't that far behind. Value investors seeking to harvest cash from turnaround stories should instead focus on Panasonic and Sony. These companies trade at low valuations because of reluctant domestic investment. Sony in particular is the most promising turnaround stock because its management is making meaningful changes by selling non-core assets and focusing efforts on its TV segment.