Sliced In Half: 7 Mid-Cap Disasters Worth A Look

by: Alan Brochstein, CFA

Last week I took a look at the 14 stocks in the S&P 500 trading at less than half their 52-week highs. The article was well-received, generating some very thoughtful comments. As I had suggested, people seem to pay way too much attention to stock market "road-kill", so I guess I shouldn't have been too surprised by all the interest. My belief is that usually these stocks are half-off for a reason. I pointed readers to an article on stocks quietly breaking out to multi-year highs - these are the kind of stocks I recommend focusing on. Not surprisingly, my link must have been broken. That article, written the previous week, has just a single comment on it.

So, I am going to share my warning again: If you eat out of the garbage can, you are likely eating garbage! Now, with that said, I think that if you are willing to look at smaller, less liquid names, your chances of finding something overdone to the downside go up a lot. The good news is that there are a lot more stocks to investigate as well. For instance, the Russell 2000 (NYSEARCA:IWM), the best known of the Small-Cap indices, currently has 265 companies trading at less than half their 52-week high. I will now share my analysis of each of them. Just kidding.

My guess is that the typical reader was familiar with all or almost all of the names in the S&P 500 that did the 2-1 split without issuing the additional shares, but if I shared the entire list of Small-Cap dogs, most readers would recognize only a handful. This is where screening can come in very handy.

Instead of looking at Small-Caps today, I will focus on a smaller universe. Perhaps next week I will dive into the tiny stocks, but today I am going to apply a screen to the Russell Mid-Cap index, which has about 782 members according to Baseline, my screening tool. For those not familiar with this index, it is the Russell 1000 less the Top 200 (the largest 200). Forty-five (almost 6%) are trading below 50% of their 52-week high. Note that 10 of these are also in the S&P 500.

There are several ways to narrow the field initially, creating a triage of sorts. There is no right answer - any screen can accidentally kill off some great candidates and include some that might just kill the potential buyer. Here is what I chose to do:

  • Net Cash
  • Positive Earnings
  • Consensus 2013 Earnings Growth > 10%
  • Positive Tangible Equity
  • 3-year Price Return > 0 (If it's down since May 2009, it's a dog)

Here are the 7 that met the criteria:

Again, the source of the data is Baseline (except for the second-to-last column). Please keep in mind that these aren't recommendations, as I closely follow only one of the names. I have sorted them by a number that I need to explain: Seeking Alpha Number. Earlier this year, Seeking Alpha began sharing the number of members who receive real-time alerts who include the symbol in their watchlist. I am still not entirely sure how to use this information, but it certainly can be useful in assessing what stocks people care about. To put things into perspective, the most widely followed stock is also the largest stock in the S&P 500 - it now has over 45K. So Molycorp (MCP) isn't exactly winning the popularity contest, but it is more than 10X more popular than the last name on the list. As long as I am on MCP, let me point out that I included it despite the fact that it's not up (or down) over the past three years, as it began trading almost two years ago.

I included a few other data, including the historical 3-year earnings growth rate, the forward PE (and relative to the five year average) and short-interest. I shaded in red those names with more than 20% short-interest and yellow the company between 10-20%. As a reminder, all of these companies have no net debt. In fact, with the exception of MCP, none of them even have debt.

I haven't looked too closely at MCP. From a purely technical perspective, this one isn't appealing to me, as I don't like to bet on triple-bottoms. It needs to make a good low. I also have some partial exposure to rare earth through a holding in my Top 20 Model Portfolio. As the high number of followers and massive short-interest suggest, this is a pretty controversial name. Earlier this year, they sold 12.5mm shares (at 31.218) to Molymet and now has over $600mm in cash with about $198mm in debt. They also announced a massive acquistion of Neo Material Technologies, spending $1.3 billion. The bid was made partially with stock (29%) and hasn't closed yet (May 30th), but the stock would fall off this list following the closing as they will have some net debt. One thing that this company has going for it is huge insider ownership (mainly founder Ross Bhappu, at 14%), with 20% overall. CEO Mark Smith has a 951K share stake.

Riverbed Technology (NASDAQ:RVBD) is another one I have never really looked at too closely. Insiders own 9% of the company, which is encouraging. The company's Steelhead products speed up wide area networks (WAN). This stock has usually been too expensive to interest me, but the current valuation of 16PE is about as low as it has ever been. With about 20% of the market cap in cash and investments, it's even cheaper than it appears. 2012 is looking to be quite slow, with analysts forecasting just 7% EPS growth but 14% sales growth. My quick read of transcript from the most recent conference call seems to suggest that the company is struggling a bit with execution as they become a multiproduct company. To address the issues, they have hired a Chief Market Officer and are working more with partners (I recall an alliance with Akamai (NASDAQ:AKAM)). Note to self: Look more closely into this one.

Deckers (NASDAQ:DECK) is one that makes me wish I had a short-focused model. I have never spent a lot of time with this one either, which is surprising given my surprisingly strange interest in shoe companies and shoe retailers, but a subscriber to my blog asked me to take a look at it when it was in the high 60s in March. I didn't like the chart at all, but, more importantly, I was alarmed by the very high margins. Having witnessed the Skecher's (SKC) debacle and many other margin crushes, I am always concerned with potentially unsustainable margins. At this point, their inventory remains quite elevated ($208mm vs. $107mm a year ago) as sales decelerate sharply.

Atmel (NASDAQ:ATML), a maker of microcontrollers (62% of sales in 2011), had an awesome 2010-2011 (sales grew 50%), riding the "touch" wave, but it could very well be a one-hit wonder, as analysts are looking for a double-digit drop in sales in 2012. Their customer list is broad and seems to include everyone but Apple. Inventory rose 12% from a year ago, while sales fell 22%. Cash represents about 10% of the value of the stock. When it comes to micro-controllers, I'll stick with Microchip (NASDAQ:MCHP).

Acme Packet (NASDAQ:APKT) is another Technology stock that has always seemed too expensive for me. Insiders own 16%, including 6.4% for CEO and founder Andrew Ory. Like RVBD, sales are expected to slow this year, but earnings are actually forecast to decline. Cash represents 24% of the market cap. I took a quick look at the transcript from the Q1 conference call, and the CEO's bullishness (confirmed guidance for 10% annual sales growth, "never more excited") is at odds with the price action. One issue is that they did an acquisition that will dilute earnings by about 5% for the full year. Another is that the year is quite back-end loaded - 58% of sales are forecast in H2.

Carbo Ceramics (NYSE:CRR) makes me wonder if I am actually the fly and not the windshield. I have followed this one for many years, and I added it to my Top 20 Model Portfolio after the disastrous Q4 earnings report. We sold some near 108 in Mid-March but added some back a few weeks ago below 85 too. It concerns me that it is so heavily shorted. The company, which makes ceramic proppants (and rosin-coated sand) used in fracking, was hit hard by the collapse in dry gas drilling (Haynesville) but has plenty of demand in oil and liquids shale plays. The challenge is that they lack infrastructure and are taking a hit to profitability. I was disappointed to see the big chop to estimates again after Q1 and had to lower my target (to 135, based on 18 PE a year out). To me, this is a great example of why bottom-fishing in smaller companies can make sense. It's a volatile stock, and likely never should have traded at 183 last summer. I recommended a short at the time on my blog. So, half-off is easier when full retail price is so high! I have to admit to being concerned with the chart - hopefully it is able to hold the 80 level.

Last up is Polycom (NASDAQ:PLCM), which had a horrible quarter. This is one I have followed casually since 2001 - videoconferencing seemed to offer so much promise after 9/11. Well, more than a decade later, the earnings and sales have grown, but the stock is sitting almost exactly where it was in August 2001. With about $3.50 per share in cash, the 13PE seems awfully attractive. Reviewing the transcript, the company was hurt by slowing government spending in many geographies. The CEO cited more of a "solutions" sales effort, which may be slowing sales as customers spend more time evaluating (seemingly positive longer-term), but he also admitted being too aggressive by extrapolating a strong Q4. The company's CEO is very sales-oriented - he used to be a Cisco (NASDAQ:CSCO) salesman/marketing pro and was the CEO of Tandberg, which Cisco acquired. He arrived in 2010, and the stock has now round-tripped after tripling. This company could have some strategic interest to another hardware company or maybe even Microsoft (NASDAQ:MSFT), which has a sales alliance with the company. Note to self: Look into this one too.

So, again, I want to warn against trying to bottom-fish stocks that have been cut in half. The screen I designed was designed to narrow the universe a bit and hopefully improve the odds of finding a stock worth pursuing. I shared my nervousness about CRR, which I own in my model and continue to like, and RVBD and PLCM look most interesting to me. As always, I look forward to input from those of you who follow some of these stocks more closely than I might.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: CRR is in one or more model portfolios at Invest By Model