Earlier this month, I talked about finding value among some of the market's most beaten-down stocks. These were all stocks that are trading well below their tangible book value, which means that investors have largely given up on them. But I believe the stocks I highlighted there are still backed by businesses that are chugging along and pumping out cash flow.
In the short time since that article was published, one of those five stocks has already been a big winner for investors. The company is Marshall & Ilsley (NYSE: MI) and it's up more than 20% thanks to the announced acquisition by Bank of Montreal (NYSE: BMO).
Time for a little self-congratulations and a nice pat on the back?
Not so fast
Psychological well-being can be improved by focusing on the positives in life. You know, like the time the grocery line was short, or when somebody actually let you switch lanes in bumper-to-bumper traffic.
When it comes to investing, though, I like to spend a good deal of time thinking about what can go wrong. This is particularly important when you're dealing with the beaten-down companies that get your hands Dirty Jobs-dirty. The cost of ending up with a bad apple from this group doesn't mean a few percentage points of underperformance, it often means a complete and total loss.
Unfortunately, investors probably don't think about this quite enough. They spot a cheap stock like, say, Ambac (pre-bankruptcy filing, that is) and see the huge gains they could reap if it made a fearsome back-from-the-dead comeback like Sirius XM or Ford.
Except in the case of large, recent bankruptcies like General Motors or Lehman Brothers, bankruptcies tend to slip into the background. And Wall Street likes it that way -- they do better when investors are optimistic and there's lots of activity in the markets.
With the successfully turned-around companies the ones still around to tell their tales, many investors forget about Circuit City, Interstate Bakeries (now Hostess Brands), Reader's Digest, Linens 'N Things, Bethlehem Steel, Musicland, and the many, many, many other companies that have ridden bankruptcy into the dusty pages of the history books.
I like digging through the trash bin to find bargain stocks. It's a part of the market that many investors have abandoned completely, so there's more opportunity for inefficiencies -- aka mis-pricings -- to pop up.
But as the above section suggests (exhorts?), caution is the watchword since we're talking about an active minefield here.
The first rule, which I emphasized in my previous article, is that trying to play sharpshooter and bet the house on one super-cheap stock is probably a bad idea. Maybe you'll hit it on the nose and make a killing (a la Ford) or maybe you'll crap out and lose everything (cough, cough, GM). I think the odds tend to be in investors' favor in this dark corner of the market and so putting together a basket of downtrodden stocks can deliver attractive returns while cushioning against the untimely death of any individual company.
But what companies are fit to be part of your low-priced portfolio? Low price in relation to value is an obvious qualifier -- I generally look for a substantial discount to tangible book value as a gauge of that. Positive cash flow from operations -- better still if it's positive free cash flow -- is another good qualifier. Not every company that maintains positive cash flow survives, but few that have consistently negative cash flow live to tell the tale. And finally -- and this is something you can't quantify -- you should understand the company's business, why it's in trouble, and what it will take for things to turn around.
Again, none of these things will guarantee that you'll pick only winners. What we are trying to do is simply pick out the companies that have the highest probability of turning things around so that on a group basis we do well.
With that, here are five more stocks to put on your dumpster-diving radar.
Price / Tangible Book Value
Trailing Cash Flow From Operations
|Hartford Financial (NYSE: HIG)|
|National Western Life Insurance(Nasdaq: NWLI)|
|Hercules Offshore (Nasdaq:HERO)|
|SkyWest (Nasdaq: SKYW)|
|Banner Corp (Nasdaq: BANR)|
Source: Capital IQ, a Standard & Poor's company.
Financials have a healthy representation here, with Hartford, National Western, and Banner all flying that flag. This isn't particularly surprising to me. The financial industry got absolutely clobbered during the financial crisis and ensuing recession and many investors have sworn off financials as a result. For investors willing to do some digging and be choosey, I think this has created some opportunities in banking and broader financial services.
Hercules has faced significant headwinds as shockwaves from the disaster in the Gulf of Mexico reached far wider than just BP. The fear over what would happen to BP in the wake of that mess led me to get bullish on the stock, and it has led some of my fellow Fools to look toward Transocean. I think Hercules could prove another stock that will rebound as the Gulf mess continues to move into the rearview.
Finally, airlines aren't the usual fare for me when I'm looking for longer-term holdings, but SkyWest looks to be a steal right now. It's in a decent position as far as its debt goes, it's producing plenty of cash flow to fund its capital expenditures, and is even reasonably profitable.
Think I've missed a stock that's been so beaten down it's too cheap to pass up? Head down to the comments section and share your pitch.
© 2010 UCLICK L.L.C.