3 High-Risk, High-Reward Stocks

Includes: AA, GNW, HTCKF
by: Michael Fu

Everyone, even value investors, should keep their portfolio interesting by selecting a few high-risk, high-reward stocks (maybe target 10% of your portfolio to these high risk stocks). Even pension funds will typically establish 5-10% of their portfolio to higher risk, higher return investments such as venture capital and private equity. Furthermore, with the markets still trading near all time highs, long-term stable moats like McDonald's (NYSE:MCD), Pepsi (NYSE:PEP), and Proctor & Gamble (NYSE:PG) are trading at P/E multiples of 18-20x that are just a little rich to establish new positions in. This article will discuss three speculative stocks, two of which trade below book value, which I believe may be worth rolling the dice on at current price points: Genworth (NYSE:GNW), Alcoa (NYSE:AA), and HTC Corp (OTC:HTCKF).

Genworth (100% upside)

Genworth has three main lines of business including life insurance (60% of sales), mortgage insurance (20% of sales) and international payment protection (8% of sales). Genworth's market cap is $4.6 billion, with 2012 sales of $10 billion and net income of $300 million (3% net margins). The company currently trades at 9.0x 2013E P/E and 0.3x P/B.

Life Insurance: Genworth dominates the long-term health insurance business, with 40% market share (and 60% of Genworth's sales). However, people are living longer, medical care costs continue to rise, and interest rates (the return that the float from insurance earns) have remained low. However, the new CEO, Tom McInerney who joined in January 2013 with prior work experience at ING Groep (NYSE:ING) and Aetna (NYSE:AET), has begun to petition individual states to raise insurance premiums to help shore up the profitability of the life insurance business. Life insurance competitors include ING Groep and Metlife (NYSE:MET). ING trades at 5.5x 2013E P/E and 0.4x P/B, but has more exposure to Europe (note that it is looking to IPO their U.S. insurance business). Metlife trades at 7.0x 2013E P/E and 0.6x P/B. Note from a previous article the risks involved in investing in financial companies (banks and insurance companies), given the difficulty in valuing the financial assets on their balance sheet.

Mortgage Insurance: Genworth provides mortgage insurance in three primary markets: U.S., Canada, and Australia. The rebound in the U.S. mortgage market provides the best potential upside. Housing starts are expected to grow 25% this year, and the Federal Housing Administration is pulling back and encouraging private capital to come back into the market. Competitors include Radian (NYSE:RDN) and MGIC (NYSE:MTG), whose stocks have rebounded 300% and 500% in the past 6-9 months, compared to Genworth's 100% rebound. Radian currently trades at 2.1x P/B and MGIC trades at 4.8x P/B.

Alcoa (50-75% upside)

Alcoa is the world's largest aluminum player, capturing 20% of alumina market share and 10% of aluminum market share globally. As mentioned in a previous article, Alcoa is currently the cheapest stock, based on a P/B multiple, in the Dow Jones Index (NYSEARCA:DIA). Alcoa currently trades at 5.9x 2013E TEV/EBITDA, compared to historical average of 6-13x. On a 2013E P/E basis, the company trades at 15.2x, compared to historical average of 8-25x. On a P/B basis, the company trades at just 0.5x.

Over the past several years, the company has transformed its business from low margin downstream business (Alumina and Primary Metal) to higher margin upstream business (Rolled and Engineered). In 2012, the higher margin upstream business made up 70% of the company's operating income.

HTC Corp (50-75% upside)

HTC is a Taiwanese mobile manufacturer that makes smartphones for both the Android and Windows OS platforms. Since I wrote about HTC a few weeks ago, the stock has been up about 15%. The latest HTC One has received strong reviews against both Apple's (NASDAQ:AAPL) iPhone 5 and Samsung's (OTC:SSNLF) Galaxy S4. The company sold 45 million handset in 2011, but with the launch of Samsung's Galaxy S3 and iPhone 5 in 2012, HTC's units sold declined to 30 million in 2012. The bet is that the latest HTC One will help the company get back to more of a 45 million units per year level. See my previous article referenced above for valuation details on HTC.

If you're going to speculate on these high risk, high reward type plays, don't get greedy and put too much of your portfolio at risk. But I believe it does make investing more interesting to have a few higher-risk plays as part of your portfolio. Good luck as always.

Disclosure: I am long OTC:HTCKF, AA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I'm looking to also maybe establish a small position in GNW.