"Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria." - John Templeton
One of John Templeton's mantras was "Outperforming the majority of investors necessitates doing what they are not doing." Moreover, he didn't simply want to bet against the crowd, he looked for opportunities where the stock was at its "point of maximum pessimism." I have selected five companies to consider that may fit Templeton's definition. We will attempt to distinguish if these stocks are value trades or value traps.
A value trap is a stock that appears to be a bargain based on fundamentals but has no catalyst for growth. The stock traps investors when they buy into the company at low prices and the stock never recovers. Sometimes stocks are down for good reason. Sector, industry or company specific headwinds may be so strong and prevalent the company may never recover.
On the other hand, value trades are companies where pervasive cynicism about a stock or sector has driven the price so low that it exaggerates the investment's perils and belittles its future prospects. These are value trades or buying opportunities. In the following sections we will attempt to discern if these stocks are indeed contrarian buying opportunities.
The stocks selected are trading on average 49% below their 52-week highs and have 54% upside potential based on analysts' estimates. Nokia (NOK) is the only one trading above its consensus price target but is still down 60% from its 52 week high. This fact alone carries little weight, but it's a good starting point when looking for buying opportunities.
Additionally, the five stocks have some positive fundamentals, potential growth catalysts and share prices trading at or below $5. Stocks trading for $5 or less tend to be more volatile with frequent, larger percentage moves in the stock price. This provides the opportunity for greater returns (or losses) relative to the market.
In the following sections, we will perform a review of the fundamental and technical state of each company to determine if this is the right time to stay with the position or sell out. The following table depicts summary statistics and Friday's performance for the stocks. The following charts are provided by Finviz.com.
Alcatel-Lucent, S.A. (ALU)
The company is trading 62% below its 52-week high and has 36% upside potential based on the analysts' mean target price of $1.52 for the company. ALU was trading Friday for $1.12, flat for the day.
Fundamentally, ALU has several positives. EPS growth for this year and next year is expected to be over 200% according to Finviz.com. ALU is trading for approximately 60% of book value and has a PEG ratio of 1.27. The company has $2.78 in cash per share. Book value per share is $1.92.
Technically, ALU may have turned the corner. All the major moving averages are beginning to flatten out. The stock has put together a nice period of consolidation over the last few weeks bouncing off its 52-week low in late July.
Alcatel-Lucent appears to be rallying thanks to the relatively positive results posted for rival Nokia. Nokia swung to profitability regarding operating income and revenues rose 3% year over year. This bodes well for ALU's chances. The risk reward ratio is favorable at this point. This is a value trade.
Advanced Micro Devices, Inc. (AMD)
The company is trading 74% below its 52-week high, and has 89% upside potential based on a consensus mean target price of $4.11. AMD was trading Friday for $2.18, down 16.79% for the day setting a new 52-week low.
Fundamentally, AMD has some positives. AMD's EPS is expected to grow by 32% next year. AMD trades for 4.54 times free cash flow. The company has a forward P/E of 7.52. Insider ownership is up 74% over the last six months. On the other hand, sales and EPS are down 10% and 40%, respectively, quarter over quarter. ROE is negative 45.61%, and the company sports a -10% net profit margin.
Technically, AMD's chart is the definition of a falling knife. The stock is in a well-defined downtrend. The stock is nearing oversold territory with a RSI of 35, 30 or less is considered oversold.
I have had AMD in the penalty box for good reason. The company reported more bad news at their Q3 2012 earnings announcement. AMD got downgraded to Market Perform by FBR's Craig Berger. Berger is worried about AMD's cash burn, lack of gross margin guidance, and upcoming price cuts. Even though AMD is down significantly, this may not be the point of maximum pessimism. I can't step in front of this train. This is a value trap.
Frontier Communications Corporation (FTR)
Frontier pays a dividend with a yield of 8.41%. The company is trading 17% below its 52-week high and has 9% upside potential based on the consensus mean target price of $5.17 for the company. Frontier was trading Friday for $4.76, down nearly 3% for the day.
Frontier has some fundamental positives. The company is trading for slightly over book value, 93% of sales and has a forward P/E of $17.61. The company's gross margin is 90.75%.
Technically, Frontier has been in an uptrend since May. The stock is up an amazing 32.45% over the last quarter. The golden cross was achieved at the beginning of September. This is a very bullish development.
The latest news is Frontier Communications has sped up broadband deployment to Oregon and the State of Washington. This is good news for the company and bodes well for future organic growth prospects. The lower dividend has provided some relief as well.
I have been behind the stock since the $3 mark. I see the recent pullback and bounce off the 50-day sma support line as a bullish event and the 8% dividend provides some insurance. The stock is a value trade here.
The company is trading 60% below its 52-week high and 15% above its consensus mean target price of $2.33 for the company. Nokia was trading Friday for $2.74, down over 2% for the day.
Fundamentally, Nokia has some positives. Nokia is trading for approximately 88% of book value, 24% of sales and has $3.29 in cash per share. EPS next year is expected to rise by 78%. Nokia pays a dividend with a 9.22% yield.
Technically, the stock has rebounded nicely since July and has established an uptrend. The stock is currently in breakout position at the apex of a descending triangle. This is usually when a major breakout move will occur. Nokia is in the final leg of a tug of war between bulls and bears and somebody is about to win.
As I stated in my previous missive regarding Nokia, the company is down after reporting its Q3 results. Nevertheless, I see this as a buying opportunity. There were some positive developments cited in the report. Nokia swung to profitability regarding operating income and revenues rose 3% year over year versus an 8% loss the previous quarter. A 29% increase in Asia-Pac sales was responsible for the growth. With a dividend yield of nearly 10%, the stock looks attractive at this level. The risk/reward ratio looks positive for the stock here. This is a value trade.
Vringo, Inc. (VRNG)
The company is trading 31% below its 52-week high and 154% above its consensus mean target price of $10.00 for the company. Vringo was trading Friday for $3.93, down over 5% for the day.
Fundamentally, Vringo has some positives. Vringo's institutional transactions are up 135% in the past three months. The company has a gross margin of 74%.
Technically, the stock is stuck in a trading range between $3 and $6 with volatile swings from top to bottom of the trend channel. This is standard behavior for patent lawsuit plays.
The Vringo situation is basically a patent play. I don't normally get involved in patent plays because it's not about the fundamentals, it's about winning a patent case and I'm not a lawyer by any means. The issue is, patent law suits can often go on longer than investors can stay solvent. The stocks involved often have wild swings as motions and appeals are won and lost.
Even so, the fact that SA author James Altucher is involved intrigues me. He is intimately involved in the situation and wrote a great article making the case for Vringo. Altucher says Vringo could be a three bagger.
Vringo is a highly speculative play I have been looking over for quite some time. I feel you should have a small percentage of your portfolio dedicated to a speculative long shot. Nonetheless, this one is not a value trade or trap, it's a crapshoot. Roll the dice at your own risk.
The Bottom Line
The focus of the markets will most likely be on earnings again Monday. The market began to drop precipitously Friday as stocks recorded their worst one-day fall in nearly four months. Disappointing quarterly reports were telling of a sluggish global economy. I see any potential sell off as a buying opportunity. The market always bounces back. This is a buy on the dip scenario.
I posit QE and other central bank procedures will bring about a rally in the near future. ALU, Nokia and Frontier are value trades I like right now. If you choose to start a position in any stock, I suggest layering in a quarter at a time on a weekly basis at a minimum to reduce risk. Build the position slowly. You can also set a 5% trailing stop loss order if you wish to minimize risk further.
Additional disclosure: This is not an endorsement to buy or sell securities. Investing in securities carries with it very high risks. The information contained within this article for informational purposes only and is subject to change at any time. Do your own due diligence and consult with a licensed professional before making any investment decisions.