Bargain hunting for stocks
Today I am going to try to do something I haven't done well in the past — select a few winning stocks that sell for $5 to $10.
I have written seven such columns in the past, the earliest in 2001 and the latest in 2011. Only three of my seven sets of recommendations beat the Standard & Poor's 500 Index. On average, the seven lists returned 3.4 percent on a 12-month total return basis, compared with 6 percent for the S&P 500.
My average return was dragged down by a couple of real clunkers I selected in 2006, Sea Containers Ltd. (SCR/A) and Journal Register Co. (JRCOQ). Both companies eventually went bankrupt. I noted the bankruptcy rumors swirling around Sea Containers in my 2006 article, but didn't expect them to prove true.
So why on Earth am I trying again?
First, there's a matter of principle. Most of my recommendation series have done well, and beaten the S&P. But if I only continue the more successful series, I would be deliberately introducing a “survivorship bias” that would make me look more infallible than I am.
Second, I'm stubborn.
Third, there is a group of investors out there that likes to make its stock selections in the $5 to $10 range. One can buy 100 shares of a low-priced stock for less than $1,000.
Low-priced shares usually haven't been discovered yet by institutional investors, many of whom are prohibited by their investment guidelines from purchasing stocks below $10. So these stocks may gain altitude once they exceed $10 and institutions start paying attention.
Let's make a clear distinction between undervalued stocks and low-priced stocks. To tell if a stock is a bargain, an investor should rely on financial ratios such as the ratio of the stock price to earnings, revenue and book value (corporate net worth per share).
A low-priced stock, by contrast, simply denotes a stock selling for $10 a share or less. In isolation, the stock price tells you little. It may be a bargain, or it may be expensive.
Today, I am trying to identify a few stocks that are both low-priced and undervalued.
The last column I wrote on this subject, on June 28, 2011, was a modest success, returning 4.9 percent compared with 4.8 percent for the S&P 500 on a 12-month total-return basis. The best gainer was Great Dredge Dock Co. (GLDD), which returned 26 percent in 12 months.
The worst loser was Xerox Corp. (XRX), which fell about 22 percent. The three other recommendations — Continucare Corp. (CNU), Hawaiian Holdings Inc. (HA) and Sparton Corp. (SPA) — had single-digit gains.
Now for some fresh picks.
• Regions Financial Corp. (RF) is a bank holding company based in Birmingham, Ala. It controls about 1,700 branch offices in Texas, the South and the Midwest.
Regions Financial suffered badly during the financial crisis and still has problems with nonperforming loans. However, I think those problems are fully reflected in the stock price, which is less than book value. The stock is a little above $9.
Analysts absolutely hated Regions two years ago. Today, with the stock up almost 50 percent from then, most analysts like it.
• Next up is Leapfrog Enterprises Inc. (LF), a maker of educational games and software. After losing money most years from 2004 through 2009, Leapfrog has turned a profit three years in a row. It sells for just under $10 a share, which is about 10 times earnings. I also recommended Leapfrog a week ago, in a column about stocks with high profitability and low debt.
• McDermott International Inc. (MDR) builds offshore oil platforms and other energy infrastructure. Its profits have been choppy, its profitability unimpressive. But the stock is so cheap that there is room for pleasant surprises. It trades at about $8.50, which is below book value.
• If your investing guidelines permit the purchase of firearms stocks, Smith & Wesson Holding Corp. (SWHC) looks good to me now. Increased pressure for stricter gun control, spurred mainly by the Newtown, Conn., school massacre, has depressed the stock price. The stock at under $10 a share is selling for nine times earnings, despite a startlingly high return on equity of more than 51 percent.
• My final pick is Iridium Communications Inc. (IRDM) of McLean, Va., a satellite telecommunications company. Public since 2009, it had its best year so far in 2012, earning 83 cents a share. This year, analysts look for 93 cents. The stock, a little above $7, sells for nine times earnings and 0.6 times book value.
John Dorfman is chairman of Thunderstorm Capital LLC in Boston. He can be reached at email@example.com.
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