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7 turkeys that are ready to soar
Often on Wall Street, what goes down must come up. Several of this year's biggest failures are poised to take flight in 2004.
By Jon D. Markman
One of the marvelous things about Wall Street, particularly as one year transitions into another, is that gravitational forces do not always apply. Whats down can go up, the dead can live again, and the most vibrant gymnast can finish a graceful arc up with a clumsy swing down to oblivion.
The past year has been well-populated with the undead, a reverso-world where Avaya (AV, news, msgs) is now king. The provider of communications systems to large businesses plunged 80% in 2002, only to turn around and advance better than 400% in 2003. A spin-off of the still mostly moribund Lucent Technologies (LU, news, msgs), it has performed the neat trick of becoming the top stock in the S&P 500 Index ($INX) one year after being one of the indexs worst.
Avaya had many companions on its journey from the netherworld, as the second-, third-, fourth- and fifth-best S&P 500 stocks this year all took the same path: Williams (WMB, news, msgs), an owner of gas pipelines, is up 260% this year after an 88% decline last year; PMC-Sierra (PMCS, news, msgs), a semiconductor maker, is up 255% this year after a 74% decline last year; Dynegy (DYN, news, msgs), a wholesale energy supplier, is up 240% this year after plunging 95% last year; and Corning (GLW, news, msgs), a maker of fiber-optic products, is up 233% this year after sinking 63% last year.
The hunt is on
You can bet this feat will recur in 2004 with some of the big losers of 2003. Which ones? To start our hunt, Ive combined the feathered flops from my Thanksgiving column (Give thanks if you missed these 4 turkeys) with reader suggestions in the table below. All are large companies that underperformed the market, in some cases by a lot.
| Will these turkeys fly in '04? | | Company | 12/9 close | 5-yr high | 5-yr low | P/E | % chg YTD | | LaBranche (LAB, news, msgs) | $9.29 | $28.96 | $7.40 | 13.2 | -64.7 | | Winn-Dixie Stores (WIN, news, msgs) | 9.16 | 59.38 | 7.5 | 5.8 | -39.0 | | *Qwest Communications (Q, news, msgs) | 3.51 | 65.06 | 1.07 | -- | -29.8 | | Eastman Kodak (EK, news, msgs) | 23.7 | 88.94 | 20.39 | 19.2 | -29.4 | | Newell Rubbermaid (NWL, news, msgs) | 21 | 55.19 | 18.25 | 24.7 | -28.4 | | AT&T (T, news, msgs) | 19.86 | 131.44 | 13.36 | -- | -21.8 | | Sony (SNE, news, msgs) | 33.08 | 157.38 | 23 | 73.1 | -19.5 | | Kraft Foods (KFT, news, msgs) | 31.4 | 40 | 26.35 | 15.8 | -18.2 | | *Merck (MRK, news, msgs). | 43.56 | 96.69 | 38.5 | 13.4 | -15.9 | | Safeway (SWY, news, msgs) | 19.92 | 62.69 | 16.2 | -- | -14.7 | | Verizon Communications (VZ, news, msgs) | 32.59 | 69.5 | 26.01 | 14.4 | -12.2 | | Freddie Mac (FRE, news, msgs) | 54 | 71.25 | 36.88 | 6.9 | -7.3 | | *Forest Oil (FST, news, msgs) | 26.37 | 38 | 10.75 | 13.5 | -4.6 | | *GlobalSantaFe (GSF, news, msgs) | 23.8 | 45.94 | 11.19 | 31.9 | -1.7 | | Automatic Data Processing (ADP, news, msgs) | 38.6 | 69.94 | 27.05 | 23.3 | -0.7 | | *Viacom (VIA.B, news, msgs) | 40.45 | 75.88 | 20.25 | 28.3 | -0.5 | | Harley-Davidson (HDI, news, msgs) | 46.14 | 57.25 | 11.94 | 19.5 | 0.1 | | Microsoft (MSFT, news, msgs) | 26.38 | 59.97 | 15.55 | 27.9 | 2.9 | | *Pfizer (PFE, news, msgs) | 34.39 | 49.99 | 23.66 | 33 | 14.6 | | *Bristol-Myers Squibb (BMY, news, msgs) | 25.9 | 79.25 | 19.49 | 18 | 15.8 |
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* denotes Markman selections
Whats striking about this list of big-cap disappointments is the lack of high valuations, poor returns on equity or extreme debt levels. If you didnt know their names or year-to-date results, you might conclude these look like an average group of companies. Nothing shouts disaster.
And thats the way it often goes with shunned big-caps that were once high-fliers. They obviously at one time had something on the ball, or they would never have grown to a tremendous size. But somewhere along the way, they blew a couple of quarters in a row, and earnings-momentum investors lost faith. Then perhaps they overstepped the bounds of business ethics and law by stretching results and got into accounting or legal trouble. At that point, confidence suffered and panicky employees made dumb mistakes. A decline in morale often leads to lackluster product innovation, and the exit of key executives. A couple of years go by, and you notice the companies and their stocks have fallen into a lifeless stall -- ignored by growth investors, but not nearly cheap enough for deep-value investors.
The 4-phase life cycle of a stock
This process offers a window into the four-phase life cycle of most stocks. Some fade at this point and never revive. But most others, at some point, become targets of opportunity for the value crowd.- Accumulation: At first, the vultures buying of the wretched is slow, smelly and stealthy. If detected by more-aggressive market players, its ridiculed as stupid and hopeless. It shows up as a saw-toothed flat line on a chart that once only tilted down. This is the quartile of the stock life cycle known as accumulation, and it can persist for months or years.
- Mark-up: As the deep-value guys patiently build bigger stakes of 5% to 10% or more, their peers begin to take notice, and the arrival of tag-along value buyers generates modestly levitating prices. At some point, if the value guys are right, business fundamentals under new management start to get traction, growth-at-a-reasonable-price buyers move in, and prices start to move up at a modest angle. This is the mark-up phase.
- Distribution: Then stocks with the best recovery stories -- usually with a raft of new products and executives who know how to play the public relations game -- attract earnings- and price-momentum players who push prices up at a much steeper angle. Eventually, the value funds begin to take their early-bird reward and feed the stock out to late-comers, usually the public, in a period known as distribution.
- Markdown: At this point, the stock is still at highs amid an era of good vibes and high-fives. Online message boards are alit, and fund managers chirp about unending growth prospects. Yet the stock is oddly losing upward momentum. The price hits a new high, falls back, then hits the same high only to fall back again. And then it makes one last lunge up -- which fails. After this double- or triple-top, the stock collapses into the last quartile of the cycle, called markdown. This is the swiftest and ugliest phase, when shares -- bereft of any deep-pocket sponsors -- cascade down in a few brutal days, then sink gently but steadily for weeks or months more, leaving the public wondering what the heck happened.
All of the stocks in my table are either in the markdown or accumulation phase. Most of us would prefer to catch onto a stock in the mark-up phase, because we dont have the stomach, vision or insight to be deep-value accumulators. But one gentleman who does is Thomas Kahn, a New York-based private money manager who last year and the previous year in my column suggested readers consider network equipment maker 3Com (COMS, news, msgs), then much hated at $4 (its now $8); cell phone maker Audiovox (VOXX, news, msgs), then much hated around $6 (its now $14); medical imagery equipment maker Hologic (HOLX, news, msgs), then hated at $7 (its now $15); and New York Community Bank (NYB, news, msgs), then not hated but largely ignored at $17-to-$19 (its now $35).
Benjamin Graham's grad student
Kahn, who is so old-school he actually worked with Benjamin Graham as a grad student, thinks the market is highly speculative at the moment and grouses that investors failed to learn their lesson from the bear market. People obviously havent lost enough money, he said. Theyre supposed to have learned that youre not supposed to buy stocks irrespective of price, or jump into stocks just because the market is going up to make a short-term profit.
Refusing to buy Ford Escorts for the price of a Mercedes-Benz, he and his partners have been net distributors of stocks in the past few months run-up. They anticipate an opportunity to deploy their cash in the next panic, but theyre in no hurry and are willing to underperform the market temporarily -- for months or years -- as they wait their turn to buy dollars for 50 cents.
Yet there is one group Kahn Bros. is accumulating right now: The much-reviled large pharmaceutical makers -- Bristol-Myers Squibb (BMY, news, msgs), Merck (MRK, news, msgs), Schering-Plough (SGP, news, msgs) and Wyeth (WYE, news, msgs). Heres what Kahn says about these -- listen closely to the voice of a successful vulture, the voice of an accumulator of stocks at their lows, the voice of anti-momentum:We like the big drug makers because we think the time to own these companies is when everyone thinks the pipelines are thin, not when theyve just discovered a cure for cancer. We dont know how you get hurt by taking your money out of a money-market fund earning 1% and putting it into Bristol Myers where it gets a 4% dividend yield plus potential capital growth in coming years. Theyve had problems, sure, but theyre working through them. You need to be patient as an investor. Dont buy Bristol for this year, buy it now for what itll do for you in 2006 or 2007. If you buy it now, you get a free call option on the millions they are spending on research and on investments in small biotech firms. Anyone should be happy with the prospect of compounding their money 15% over the next five years. If you buy Bristol at around $26.50, you get a big head start by earning 4.2% right off the bat forever. Now you only need the stock to go up 10.8% a year to make your 15%.
Im with Kahn for a significant rebound in the big drugmakers sometime in the next three years, if not precisely 2004. And along with them, Ill add votes for renewed interest in troubled telecom provider Qwest Communications (Q, news, msgs), oil-and-gas drillers Forest Oil (FST, news, msgs) and GlobalSantaFe (GSF, news, msgs), and media giant Viacom (VIA.B, news, msgs). They all appear to be under accumulation.
Other ideas: Scandal-plagued LaBranche (LAB, news, msgs) would certainly rebound if the New York Stock Exchange were to revert back to trading in fractions rather than decimals. Eastman Kodak (EK, news, msgs) is being touted as a comeback play by premier value manager William Miller at Legg Mason. And three others not in the table that already have begun to attract more buying interest after three years of decline -- and are thus possibly already in the mark-up phase -- are technology giants Oracle (ORCL, news, msgs), Sun Microsystems (SUNW, news, msgs) and Hewlett-Packard (HPQ, news, msgs). Ill watch all these over the next year and report back.
Fine Print
In my Oct. 1 column (The Devil wears pink: A grim financial fairy tale), I relayed the view of anomaly researcher Jim Williams that resurgence of interest in the color pink reflected Americans subconscious desire to see the world through rose-colored glasses and ignore or deny problems such as the Iraq conflict and high levels of consumer debt. A recent New York Times story affirmed the seasonal color swing: At Saks Fifth Avenue's 62 stores, traffic was brisk for the weekend," said Jaqui Lividini, the chain's senior vice president for fashion. She said that the best-sellers were luxury goods or things with a lot of color, especially anything pink, or lavender, or light green. Michelle watches, with their diamond faces and colorful bands, were moving strongly, for $1,245. Prada's pink nylon quilted bags, along with Gucci's clutch with horse bits, and Marc Jacobs Stella, one of the most popular bags of the holiday season, sold strongly. . . . To learn more about Thomas Kahn, visit his firms Web site.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm@oddpost.com. At the time of publication, Markman controlled accounts with positions in the following securities mentioned in this column: Merck, Microsoft, Hewlett-Packard.
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