DEFINITION of 'Ugly Duckling Stock'

Stock in a company that is underperforming but has the potential to significantly improve. Ugly duckling stocks can be thought of as “down, but not out.” These stocks might be considered speculative investments at the moment, but they have potential to improve and turn around because the company was strong in the past and is showing current signs of strength despite a number of weaknesses.

BREAKING DOWN 'Ugly Duckling Stock'

Stocks that the media has described as ugly ducklings include AFLAC in 2009, Best Buy in 2012, J.C. Penney in 2013 and Caterpillar in 2013. Bears might dub a stock an ugly duckling because they think the company’s business model is dead, its sales have bottomed out, the company isn’t unique enough or it has too many competitors. Those who are bullish on ugly duckling stocks will point out their positive attributes such as increasing dividends (both presently and historically), good management, lots of cash, improving sales, a promising change in branding strategy, being in a sector that is poised to rebound or a history of above-average returns on equity. With many investors shunning or overlooking these stocks because of some depressed fundamentals, their prices drop. Ugly duckling stocks, while risky because of their currently low prices, can be potentially lucrative investments for those who think they are trading below their true value. Ugly duckling stocks that improve are said to turn into swans.

There are several ways for investors to find ugly duckling stocks. They can search for companies with a low price to earnings ratio, preferably in the single digits. They might look for a high earnings yield, which shows that the company is generating a large amount of earnings relative to its stock price. They can also look for insider purchasing activity, because when company insiders such as senior managers, directors and major shareholders are purchasing the company’s stock, it probably means good things are in store.

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