By George Putnam, III
The Turnaround Letter
Most of the time, we focus on fundamental business factors that affect the values of particular stocks. But at this time of the year, we often see artificial selling pressures that may present buying opportunities almost regardless of stock fundamentals or market conditions. These selling pressures come from two sources: tax loss selling and portfolio window dressing. The extreme volatility that we’ve experience this year has produced a particularly interesting crop of year-end bounce candidates.
Tax loss selling happens when investors sell their losers to generate taxable losses to offset other gains. After the strong stock market gains of 2009 and 2010, many investors probably have some significant gains to shelter this year despite the recent volatility.
Portfolio window dressing takes place when professional managers look over their funds as year-end approaches and notice that some of their holdings are showing big losses. They would rather not have those big losers show up in their published annual reports, and so they sell the embarrassing positions to get them out of the portfolio before it is memorialized at year-end.
When the new trading year begins on January 3, 2012, this artificial selling pressure will disappear, causing many of these losing stocks to become at least short-term winners. Sometimes this year-end bounce will get certain stocks back into the limelight, and they will continue to go up for a prolonged period.
This strategy doesn’t always work, but it often does. For example, last year it worked well over the short-term, but less well longer-term. The ten year-end bounce candidates that we highlighted at this time last year gained an average of 20.8% from the beginning of December 2010 through the end of January 2011, versus a comparable gain of 8.9% in the S&P 500. Moreover, nine of the ten stocks we wrote up outpaced the S&P over that period, most of them by a significant margin. However, the returns over the last 12 months were more mixed, with the average for our group being slightly negative versus a small gain for the S&P.
Given last year’s success, at least over the year-end bounce period, we decided to try the same strategy again this year: focusing on the worst performers in the S&P 500 during calendar 2011, adjusted somewhat so that there is only one from each industry group.
Alpha Natural Resources (ANR: $24) produces coal for electric power generation and steel production. The stock’s perceived economic sensitivity hurt it as recession fears reared up over the course of the year. The pressure on the stock was increased by an earnings warning and by concerns about the integration of a large acquisition. After 2011’s year-long decline, the stock looks undervalued with attractive cash-flow characteristics.
American International Group’s (AIG: $23.31) aggressive moves into the mortgage and derivatives markets put the company at the epicenter of the financial market meltdown in 2008. It was bailed out by the government, but unlike many other financial institutions that required assistance, AIG has yet to pay back its federal borrowings. After a big year-end bounce last year, the stock peaked above 60 in early January, and it has been dropping ever since. AIG still has issues, but it also still has a respected brand, and a powerful presence in many parts of the globe. We think it could have another big bounce this year.
Bank of America (BAC: $5.44) has seen almost nothing but negative headlines since it bought Countrywide and Merrill Lynch in 2008. Nonetheless, it still has a powerful retail banking footprint, and Merrill Lynch is beginning to look like a smart pick-up. The sentiment about B of A has been so negative that even a big investment from Warren Buffett hasn’t helped the stock. But investment sentiment can change rapidly, and even a slight lifting of the gloom surrounding B of A could cause the stock to pop.
Computer Sciences (CSC: $24.43) would have had a good year except for five trading days. Four earnings releases and an update on a problem in the UK account for the entire year’s decline. And it hasn’t helped that the company has an ongoing SEC investigation into its Nordic and Australian units. Despite all this, the company’s strength in providing solutions to complex technology problems in both the public and private sectors positions it well for the future. Long-term contracts provide a measure of stability and have helped build a strong balance sheet. With the stock trading at its lowest level since 1995, it appears ripe for a rebound. In addition, it could attract the attention of private equity investors.
First Solar (FSLR: $47.86) is another stock that began the year well and then went into a prolonged slide as investors turned negative on the whole solar sector. However, with decent results and a largely debt-free balance sheet, First Solar could rebound sharply when the group comes back into favor.
Janus Capital Group (JNS: $6.60) is an investment management company with a focus on equity mutual funds targeting both individuals and institutions. The company’s specialty is growth stock funds, which are particularly vulnerable to market volatility. When equity markets firm up again, the stock should perform well.
MEMC Electronic Materials (WFR: $4.17) is a leading manufacturer of silicon wafers; the company counts most of the world’s large semiconductor manufacturers as customers. The cyclical nature of the business along with a growing exposure to the solar industry kept investors on edge through most of 2011. The company has take on more debt in recent years, which is probably adding to shareholder nervousness. But with the stock approaching a nine-year low, it looks as though most of the fickle shareholders have already abandoned ship, and so any upturn could be sharp.
Monster Worldwide (MWW: $7.31) started 2011 by rallying to a multi-year high only to begin its 2011 descent by the end of January with a 25.4% one-day drop on the heels of disappointing revenues and bookings. Monster, a global online employment search company, definitely felt the effects of subdued business confidence and rising concerns about a new recession. But the company’s brand is strong, and management appears attuned to tweaking the company’s operating model to leverage developing technologies.
Netflix’s (NFLX: $64.53) fall from grace highlights one of the more dramatic declines of an iconic stock in recent memory. Following a 73% year-to-date gain to a July high near 305, the stock has since collapsed to 69. Management made several moves which angered subscribers, and that in turn spooked investors. Management then realized the error of its ways and repealed one of the changes. While the moves tarnished the brand a bit, the company still has a strong business franchise.
United States Steel (X: $27.30) saw a sharp drop off in demand for steel products during the last recession, and so investor got very nervous as fears of a new recession picked up steam earlier this year. If those fears begin to recede, the stock should rebound smartly.
Editor’s Note: George Putnam, III is editor of The Turnaround Letter, 225 Friend St., Ste. 801, Boston, MA 02114, 1 year, 12 issues, $195. The Turnaround Letter has been providing turnaround investing advice for over 25 years. For more information on this newsletter visit www.turnaroundletter.com.
