Value Opportunities Created by Mutual Fund Selling

by: Alan Brochstein, CFA

With the year almost over, we have just crossed the end of the beginning of the window-dressing season. About half of all mutual funds ended their fiscal year last week, and you can bet that many were busy taking the wounded horses behind the barn over the past month. Who wants to show a loser to their investors? This type of behavior happens all the time, creating opportunities for new buyers. Of course, the next two months may be tough for some of these dogs, as tax-loss selling as well as year-end window-dressing continue to impact them, but it's worth at least investigating if the selling has left these stocks too cheap to pass up.

I ran a screen designed to identify potential window-dressing victims that could be worth a look:

  • Russell 3000 member
  • Down more than 20% over the past year (235 names)
  • Up less than 4% over the past month (165 names)
  • Positive Cashflow (121 names)
  • Price to Tangible Book < 2X (61 names)
  • Net Debt to Capital < 30% (40 names)

Here is what we got ():


Not surprisingly, most of the names are Small-Cap, though a few are Mid-Caps. I sorted them within sectors by one-year price change. At the bottom, you can see that the average decline has been 32% over the past year. Pretty awful compared to the S&P 500's 14% improvement. I also included 2-year performance. Most of these stocks are down from then, with the average at 34%, so these are pretty ugly stocks in general. I happen to own 3 of them in my Top 20 Model Portfolio, all added in the second half of the year.

While it wasn't part of the screen, I also included sales growth and PE ratios. While many are shrinking, which usually suggests extra caution, 16 have shown sales growth over the past year. As far as the PE ratios, most of these stocks are experiencing depressed earnings, but 9 have PE ratios below 20.

In the Consumer Discretionary sector, the CEOs just departed from Office Depot (NYSE:ODP) and Charming Shoppes (NASDAQ:CHRS). I don't follow any of these closely, but Citi Trends (NASDAQ:CTRN) looks interesting given the growth and valuation parameters. Coldwater Creek (NASDAQ:CWTR) just had a horrible quarter after looking like it was on the rebound.

Winn-Dixie (NASDAQ:WINN), the sole representative from the Consumer Staples, is one of the ugliest charts I have seen in some time. Grocery stores are tough...

In the Energy sector, we own Comstock Resources (NYSE:CRK), a Haynesville play, in the Top 20 Model Portfolio. In general, these companies have been pounded by falling gas prices.

It's not surprising to see several Financials given how beaten up the sector has been in general. Many of these have low financial leverage and are growing. I don't follow any closely.

In Healthcare, I tend to be wary of value stories generally. I used to follow Surmodics (NASDAQ:SRDX) closely and am waiting to see who they hire to replace their CEO who left abruptly this summer. It's a very interesting company that has been fighting decline in its main business but just can't seem to show enough traction in its growth areas. I would note that the sales aren't down as much as they appear - they had an exceptional revenue recognition due to the early termination of a collaboration with Merck (NYSE:MRK). RTI Biologicals (NASDAQ:RTIX) is one that I have had my eye on. The company seems to be in a great area (using biological material for bone repair), but there are some questions about their alliance with Medtronic (NYSE:MDT), which just bought a competitor. Albany Molecular (NASDAQ:AMRI) has had a lot of lumps over the years and seems broken.

I like the Industrials and have shared my thoughts recently on the sector. Several of these are in construction, where sentiment is extremely negative. In the Top 20 Model Portfolio, we added Orion Marine (NYSE:ORN) this summer. The company has seen its longer-term secular promise (Panama Canal widening that will feed demand for harbor expansions in the Gulf and the Atlantic) hurt by cyclical pressures. Insteel (NASDAQ:IIIN) is one we added in October after they reported. Things might not get better soon, but they probably can't get worse. I don't follow too many of the rest, though I have met with management from Energy Recovery (NASDAQ:ERII). Desalination is a promising long-term trend, and the fact that ERII has acquired its prime competitor leaves it poised to benefit when the industry improves.

Finally, there are a few Technology names. I don't follow any of these closely.

As I always say, screening is just a start. I have done the work on the three names we own in the Top 20 Model Portfolio, and I find several of the remaining 37 names interesting. It's important to remember that these companies might face some continued near-term pressure over the balance of the year, but they seem beaten up enough to consider nonetheless.

Disclosure: Long CRK, IIIN, and ORN in the Top 20 Model Portfolio