What is an 'Ugly Duckling Stock'

An ugly duckling stock is the stock of a company that currently has weak performance, but that has the potential to significantly improve before too much time elapses. Some investors consider ugly ducklings to be stocks that are down, but not out.  Although these securities might be considered speculative investments today, their company fundamentals signal that they have the potential to recover. This is often true of companies that had strong results in the past and are now showing renewed signs of strength that are not reflected in their current stock price.

BREAKING DOWN 'Ugly Duckling Stock'

Ugly duckling stocks might be considered to be unfavorable investment opportunities by bearish investors, who may believe the company’s business model is outdated, its sales have bottomed, the business isn’t unique enough or the company has too many competitors. At the same time, investors who are more bullish on ugly duckling stocks will highlight their positive qualities, which might include increased dividends both presently and historically, strong management, good cash flows, improved sales, an encouraging change in branding strategy, being in a sector that is poised to rebound or a tradition of above-average returns on equity.

Many investors shun or overlook certain companies, even those that have historically performed well, because of a current shortcoming that causes their prices to decline. Nevertheless, ugly duckling stocks, which pose risks because their value is presently low, can be potentially lucrative investments for investors who believe the stocks are trading below their true value. Ugly duckling stocks that improve are said to turn into swans. Within this context, the word swan is sometimes spelled out as “sleep well at night.”

Investors can find ugly duckling stocks by using one or more of several approaches. One method is to search for companies that have low price-to-earnings ratios (P/E), preferably in the single digits. Researching what a company’s P/E ratio was in prior years could provide insights into the long-term value of its business and help an investor decide whether or not the stock is worth buying. One might also consider stocks with high earnings yields, which show that a company is generating strong earnings relative to its stock price. It might also be helpful to track insider purchasing activity, because when a company’s senior officers are purchasing their firm’s own stock, it often means good things are in store.

Ugly Ducklings that Recovered

There are many ugly duckling stocks that later became considerably profitable for investors. One such example is Facebook. Due to a weak initial public offering and some early struggles, the company’s stock price reached a low of $17.55 per share in September 2013. Many investors wrote the company off, and some media critics felt it was excessively priced based on its sales and earnings at the time. Flash-forward five years into the future and in July of 2018, Facebook is trading at roughly $195 per share. That’s an increase of more than 1,000 percent.

And it’s not just individual companies that are called ugly ducklings. The phrase can also apply to entire asset classes, market capitalizations and even to whole geographies. For example, the media often portrayed emerging-market equities as ugly ducklings following the negative return of the MSCI Emerging Markets Index in four of five years from 2011 to 2015. However, investors who saw the potential in EM stocks were rewarded when the index climbed 11 percent in 2016 and 37 percent in 2017, which more than made up for their earlier losses.

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