Alan Brochstein Screens for Stocks Down 1/3
In September, I discussed the idea of buying stocks that are “beaten up but not broken,” with the goal of finding stocks that had declined substantially but weren’t likely “falling knives.” With stocks making new highs, I believe that many who have missed out or have been invested less than they would like to be may look to “bargains” to get involved more substantially, but this is a strategy that can be quite risky.
If you are going to try to buy stocks that have dropped a lot, I believe you can improve your chances of not buying a “falling knife” but focusing on a few technical, fundamental and valuation checks, as I shared in that previous article. With the caveat that stocks in decline can keep declining, I want to address an idea that one of my clients uses: The “1/3 Off Rule.” He likes to find “good” growth companies that have dropped by about 1/3 in price but remain in an uptrend.
Everyone’s definition of a “good company” will differ. I defined my view in late 2010, when I discussed Intuitive Surgical as an example. With this in mind, I want to screen for stocks that have dropped by about 1/3 from their highs but that might be offering good potential entries due to certain fundamental or valuation characteristics. Using Baseline, here is what I did:
· Member of Russell 3000 (2975 Companies)
· Market Cap > $500mm (1975 Companies)
· Price vs. 52-Week High < 70% (231 Companies)
· One-Year Price Return > 25% (16 Companies)
· Trailing EPS Growth > 15% (9 Companies)
· Debt to Capital < 20% ( 4 Companies)
· Positive Earnings (2 Companies)
Summarizing these constraints, we are looking for companies that have beaten the market over the past year but have corrected sharply and that have good earnings growth, low debt levels and positive earnings. Here are the two that met the criteria:
Now, before I go on, please remember that these aren’t recommendations. This is an exercise to perhaps identify some stocks to study further, but it’s also a learning experience to help you think about your own investment process.
You may be familiar with Monster Beverage (MNST), which used to be Hansen’s Natural before taking on the name of its popular energy drink, Monster, a brand that makes up about 90% of the company’s sales. While the stock may seem expensive with a forward PE near 25, the balance sheet shows cash of about $5.50 per share (about 10% of the market cap), and the growth has been robust. The stock took off from 20 in mid-2011 and traded as high as 79 earlier this year on rumors that Coca-Cola (KO) might be considering acquiring the company. The stock has corrected as those rumors haven’t proven to be true, at least yet. Fundamentally, the growth remains strong. In the most recent quarter, sales grew 28% from a year ago, similar to the first quarter. Net income grew 30%. The consensus analyst earnings estimate for 2013 suggests growth could slow but would still be 23%. Insiders own an impressive 17% of the company.
I am more familiar with Liquidity Services (LQDT), which is a member of my 100-stock watchlist. This company, based in Washington, D.C., provides reverse supply-chain services to retailers (meaning it helps them get rid of “returns”) and also helps government customers auction off assets. The stock exploded a year ago after the company acquired a similar company, Jacobs Trading. Even excluding the contribution of acquisitions, the growth has been strong, and the company believes it has only 1% share of the large and highly fragmented industry. Insiders own about 27% of LQDT. Founder and CEO Bill Angrick had announced a trading plan earlier this year to sell some of his holdings (almost 7mm shares), but he cancelled the plan after the stock fell sharply. When the company traded above 66 in May, it was valued at approximately 36X forward earnings, which seemed rather aggressive. The current valuation of approximately 20X, on the other hand, compares favorably to its growth prospects as well as its history over the past five years.
Keep in mind that screening is only an initial part of a more complete investment process, which includes a more thorough investigation of the company’s prospects. As I have shared, our goal today was to find some stocks with good longer-term price momentum and strong fundamentals but that have suffered sharp declines recently. The two stocks I discussed not only met the criteria of the screen but also have very high insider ownership, which can signal that management is on the same side as outside shareholders. Still, like any stocks suffering corrections, it’s important to understand what is driving the correction and to be aware of the potential for further price deterioration. The MNST pullback seems to be mainly a function of a rumored acquisition not panning out, while LQDT has corrected from very high valuation levels at the time as well as concerns of slowing growth.
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator
Disclosure: No positions in any stock mentioned
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