Near year-end, investors, particularly bargain hunters, should be doing their homework and compiling a list of companies with stocks that have been beaten down as a result of tax loss selling or for other reasons but that still have solid fundamentals. That way, when the selling subsides, investors will have the opportunity to book some large profits. Why year-end? Because if you do your research in December, come the new year you stand to profit from the January effect. In this article, we'll show you how a little early research, coupled with rising stocks in the New Year, can do more for your bank account than any number of soon-to-be-broken resolutions. (Find out more about the January effect, in Making Sense Of Market Anomalies.)
TUTORIAL: Behavioral Finance
Put the Financial Media to Work
One of your first steps as the year winds down should be to peruse business journals, trade magazines, newspapers and websites. This is because every year in the fourth quarter, and sometimes in the following first quarter, a number of web and print publications will review the "biggest blowups of the past year", or discuss a variety of corporate disasters or other news that made headlines. Not only does this make for good reading, but it also can be an excellent source for investment ideas.
What You're Looking For
Look specifically for stories about companies and stocks that have taken a beating due to one-time or other significant events that a company can overcome. For example, look for companies that reported large one-time accounting charges that are unlikely to be repeated in the coming year. These charges shouldn't have a lasting effect on the company, which could mean that the stock is currently undervalued. (Learn more, in The Frosty, Festive World Of Investing.)
|Example - Bad News Makes for Good Investment
Consider Apple Inc. (Nasdaq:AAPL) in late 2006. The company received a lot of flak for supposedly backdating its employee stock options. Around that time (more specifically, after the bad news regarding the options hit a crescendo in the media), its stock took a nosedive. In fact, in November to December of 2006, the stock dropped from about $93 to around $83. (To learn more about options backdating, see The Dangers Of Options Backdating.)
However, at the end of 2006, Barron\'s ran a news story about the company suggesting that the stock options news may have run its course and that it might be time to look forward. The article turned out to be right, and in January 2007 Apple\'s stock rebounded sharply. Then, after a brief lull in the spring, the momentum began to accelerate and by year-end 2007, the stock was flirting with $200 a share. (Find out why news stories can have an impact on stocks in Trading On News Releases and Can Good News Be A Signal To Sell?)
Try to get in on companies that are experiencing a negative event that is unlikely to re-occur. News articles are a terrific place to look for such companies.
Follow the Trail of Blood
Every year there are stocks that take a big beating, but in the following year, some of those under performers are sometimes known to outperform the larger market - call it the Rocky Balboa syndrome. You can't keep a good fighter down.
Beware the Analysts and Critics
One tip is to look for companies that have been downgraded by a number of analysts. The theory behind this is that harsh criticism tends to knock the wind out of stocks, forcing them to lay low. If and when the stock picks itself up off the floor, there could be a flurry of positive, upbeat research that may then drive the stock higher.
|Example - Analyst Downgrade Forces Stocks Down
An example of a big beat-down with a January pop is Yahoo (Nasdaq:YHOO) during late 2006 and early 2007. In 2006, sell-side analysts became fairly bearish as Google (Nasdaq:GOOG) gained in prominence and page views. Analyst ratings reflected this bearish attitude. (Just to give you an idea about the pummeling the stock took, early on in 2006 it was trading north of $40, but at year-end it was down near the $25 level.)
However, right after the new year the company released decent Q4 results and the Street began to suspect that management could at some point embark on a major initiative to turn the company around and become more competitive with Google. At that point, the analysts\' research and the general public\'s sentiment became a little more upbeat. Soon after, the stock popped from the mid-$20s to almost $30 a share.
Be willing to pursue even the most beaten down stocks (with solid financials) - after all, one bad match does not break a great boxer. This method of stock selection (picking among the most battered and bruised stocks) is similar to the "dogs of the Dow theory". This theory was developed and coined back in the early '90s and suggests that picking among the most out-of-favor stocks within the Dow has the potential to yield exceptional results. (To learn more about the dogs of the Dow, please see Barking Up The Dogs Of The Dow Tree.)
Give a High-Five to Stocks Under $10
Many institutions won't get into a stock, or are less likely to get into a stock, if it trades for less than or close to $10 a share. Why? Because these institutions don't want to be accused of investing in low quality, low priced stocks or "penny stocks" (even if they're not). After all, these types of stocks tend to get a lot of bad press.
Therefore, the idea is to buy into a company with sound fundamentals that trades just under that level - so that if and when it does punch through that mark, the ride to profitability can really begin.
|Example - Breaking the $10 Threshold
For example, once a stock breaks the $10 mark, like Callaway Golf (NYSE:ELY), it is available for institutional investment and can grow quite quickly. In fact, looking back there are a few instances when Callaway stock touched $10 or punched below it, but it soon popped right back up again at around year-end.
The Bottom Line
The year-end and the first quarter are terrific times to pick up stocks on the cheap. To that end, keep your eyes peeled, do your homework, check your charts and don't be afraid to look among the most heavily beaten down stocks. (Learn more about annual trends, in Capitalizing On Seasonal Effects.)