"Boomerang" Stocks for 2013
Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Much like buying and selling too early, chasing rapidly deteriorating businesses is a crux that plagues most value investors. It seems ridiculous even as I write it but it makes perfect sense in real time.
Terrible businesses tug at value investor’s emotions and they exploit the “value Achilles heel”—they’re cheap.
Growth potential, not stock price is valuable. The essence of real value investing is to buy growth at a fair value, not a “cheap” piece of junk.
Separating the Boomerangs from the Lemons
One of the sexiest ideas is that of a “boomerang” stock; a stock that’s price has been hammered unjustly, ripe for a rebound. When Fortune issued this list of the worst performing Fortune 500 stocks of 2012, (about a month ago) it made me think about boomerangs.
What makes a true boomerang? Can any of these stocks “fly back” in 2013?
|Company name||2012 Decline||Industry|
|J.C. Penney (NYSE: JCP)||-48%||Retail|
|Navistar International Corporation||-45%||Auto & Truck Manufacturers|
|Cliffs Natural Resources (NYSE: CLF)||-50%||Basic Materials: Metal Mining|
|Alpha Natural Resources, Inc.||-59%||Energy: coal|
|AK Steel Holding Corporation||-50%||Basic Materials: Iron/Steel|
|Best Buy (NYSE: BBY)||-47%||Retail: tech|
|Advanced Micro Devices (NYSE: AMD)||-56%||Tech: Semiconductors|
|NII Holdings Inc.||-75%||Communications Services|
I feel, only one has the potential: Cliffs Natural Resources (NYSE: CLF), which is a mining company that focuses on iron ore, fines and lump ore, and metallurgical coal. How can we be certain that only Cliffs is worthwhile? Simple, we evaluate the company and not the stock price; here’s our process:
Numbers=Your Anti-Dote to Bias and Emotion
Numbers don’t lie. This is always worth remembering but more so when it comes to “cheap” stocks. You should always start your search with return metrics (ROE/ROA) and price metrics (P/E and PEG) and go from there. These metrics will lead you to companies that perform well (ROE/ROA) at a fair price, and weeding companies out who don’t meet the numbers will detach you from speculation and personal bias.
This is where Cliffs excels as its numbers tell you a story worth hearing, especially in comparison to a company like Best Buy. While Best Buy does have positive earnings (an anomaly on this list) and even a low forward P/E (around 6) its negative ROE expose it.
What’s the story behind the negative ROE? The numbers are telling us that Best Buy can’t charge a premium for its products. In fact, these numbers indicate that the company is slashing prices just to compete. In short, the numbers confirm everything negative we’d assume about BBY. Meanwhile, Cliffs ROE of nearly 16% says that the company is doing something right despite demand (currently) being soft.
The Best Way Find Real Value: Think Like an Owner
Why should you think like an owner? Here’s a little secret: if you’re buying shares, you’re about to be one!
The inability to understand that simple concept has led to some of history’s worst investments (I’m looking at you “2007”).
If you were trying to envision a turnaround scenario in your head, you should think like an owner would and make sure the stock has:
A). A Backstop
Something’s wrong with the stock you’re buying; otherwise it wouldn’t be so cheap. So the first question you need to ask is: what’s the chance that this company could go bankrupt?
No business is bulletproof but considering that Cliffs business is cyclical in nature and that it’s in “metals,” which no one can deny are very much needed and not subject to fickle consumer tastes, it’s unlikely that Cliff’s will go out of business.
Contrast that with the aforementioned Best Buy (sorry shareholders). BBY finds itself in a rapidly changing industry, with an engrained disadvantage. It also needs to win over fickle consumers and change its business model. This isn’t impossible but the company that’s beaten up due to a cyclical downturn is less risky.
With every “break” the business needs to stay afloat, a risk is added.
While having safety is important, we want the business to do more than survive; at some point it needs to thrive. Does the stock you’re considering have a catalyst to do so? Well, with CLF, you’re potentially buying during a down cycle so the boomerang possibility is already there.
The lack of a catalyst eliminates consumer facing names like JC Penney and Advanced Micro Devices from the discussion. One could argue that both JCP and AMD are “cheap” because they find themselves with a deteriorating business in a rapidly changing industry. When given the choice between that scenario and a cyclical, the choice is obvious.
Finding Value=Finding a Good Company
Think about it, would it be more of a “value” to buy a McDonald’s franchise for $1M or Hardees for $700k? You don’t need to know a lick about valuation to know that the McDonald’s would be far superior, despite the higher price tag.
Cliffs has a better catalyst and more safety then some of the fledgling consumer names on this list and is performing better than some of the cyclical names (NAV, AKS, ANR). While that doesn’t mean that we should buy Cliffs today, it tells us we might be on to something and it eliminates the other stocks on this list from discussion.
They are not values; a cheap piece of junk, is still a piece of junk.
Adem Tahiri has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!