In a perfect world picking stocks is easy: find a company with solid fundamentals and growth; wait for a pullback to jump in, and then just sit back and enjoy the ride. The problem is that strategy doesn't work when things are far from perfect, as they are now. A different approach may be in order if we're going to successfully buy low and sell high.
With that in mind, I've dusted off my alternative methodology. Rather than hunting for stocks that look undervalued and should move higher, I'll first look for stocks that are going higher, and then see if their fundamentals merit such a move.
Who's Out, Who's In
To really mix things up, I'm specifically going to remove energy stocks, basic materials stocks, and large cap stocks from the search. Energy and materials stocks are basically a coin toss right now with the dollar swinging like a monkey on a vine. And large caps? Well, let's just say small and mid caps are more apt to resist market wide weakness than large caps.
The final step was to limit the search to industries that have a positive two-week performance. The overall market numbers are slightly negative for the time frame, so by default any gainers are better-than-average performers.
The stock I've listed for each industry is probably not the group leader. It's the stock I think presently offers the best risk/reward potential at its current price, and based on current fundamentals.
Internet & Catalog Retail
The S&P Small Cap Internet & Catalog Retail Index's 6.8% gain over the last two weeks to last Friday isn't anywhere near the top of the list, but the index scores some points with me for consistency. The name of the stock I'm going to present to you isn't going to shock anyone - Netflix (Nasdaq:NFLX). Say what you want about increased competition from Blockbuster (NYSE:BBI), but Netflix is still ramping up its top line, and doing so profitably. That said, I'd by lying if I told you I wasn't looking for a short squeeze here. Short interest is a hefty 35.7%. (For more on this measurement, check out Short Interest: What It Tells Us.)
Construction & Engineering
With housing and real estate in a slump, it's a little surprising to see the S&P Small Cap Construction & Engineering Index up 5.3% for the last two weeks, and higher by 13% for the last six months. KHD Humboldt Wedag International (NYSE:KHD) has not only been getting plenty of work, but has a massive work backlog.
The S&P Small Cap Telecom Services Index literally got chopped in half between September of last year and March of this year. So, the 11.7% rebound over the last two weeks (and the 20% gain for the last month) is some much-needed relief. The most interesting pick of the litter here - I'm being completely serious - is Iowa Telecommunications Services (NYSE:IWA). The company has solid numbers, although profits dipped a bit last quarter. The rumor is Iowa Telecom may be bought out by Windstream (NYSE:WIN).
Are you surprised to read that the S&P Mid Cap Soft Drinks Index is actually the mid-cap world's best two-week performer, with a gain of 11.4%? The best bet I found in this group was an American depository receipt (ADR): Coca-Cola FEMSA, S.A.B. de CV (NYSE:KOF). None of the fundamentals look phenomenal, but they all look solid.
You'd never know 2008 was a tough year judging from the S&P Mid Cap Computer Hardware Index. It's up only 3.9% for the last two weeks, but ahead by 16.0% year-to-date. Teradata Corporation (NYSE:TDC) has surfaced as one of the better values here, with a twelve-month return on equity (ROE) of 35.5% and year-over-year earnings growth of 40.8%.
Most of them are mid-caps and small-caps anyway, so when you're talking about the S&P Mid Cap Water Utilities, you're basically talking about the majority of the industry. The average stock in this group is 2.8% higher for the last two weeks, which isn't a lot, but it's a radical change from the dismal 10 months before that. The index is up 13.4% for the last month. Another ADR made its way to the top of my short list: Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE:SBS). The Brazilian water and sewage stock has actually not been a great performer lately, but it is fundamentally one of the strongest companies in the group.
Is this a backwards approach? Perhaps, but it's worked well for me when other things haven't. The whole goal is to buy low and sell high. Limiting your universe to those stocks that are at least currently on the rise makes it a little easier to find those hidden, undervalued names.
To learn more, check out Stock Picking Strategies: Value Investing.