Unfortunately, most investors get it wrong. We all fight to pile into a hot stock, retreating once the share price plummets. Of course, that’s the exact opposite of what a savvy investor should be doing. Remember — it’s not about calling a bottom. It’s about buying low and selling high. It’s a simple concept that’s goofed seemingly every day when we let our emotions creep into our portfolios.

Right now, the market is low. Some of the beaten down stocks deserve to be in the basement. But like any bear market, there are some deals out there. So who’s bullish?

Minyanville.com CEO Todd Harrison is. Harrison told Yahoo! Finance that he believes a “monster move” is in store for stocks by spring.  Harrison isn’t a perma-bull, either. In fact, he’s been quite bearish for the better part of the past year. Now, he’s telling the press that the S&P could hit 1,000 very soon.

Harrison’s prediction is closely linked to financials. He told Yahoo! that financial stocks could spark a rally due despite the intense negativity in the sector. While we find this interesting, we wouldn’t follow Harrison into his Bank of America, Morgan Stanley and Wells Fargo plays just yet…

Berkshire Hathaway captain Warren Buffett has not been so publicly bullish…but the legendary stock picker hasn’t exactly stayed quiet on the investing front. Buffett has spent his time sniping shares of the industry leading bottom-dwellers like General Electric, Goldman Sachs, and Swiss Re.

You and I may not be able to purchase preferred shares through private deals or buy up corporate debt like Buffett is doing these days. But for individual investors with a small-cap focus, there are ways to play the recession and come out on top…

• First, you need to think cheap. No, we’re not talking about fundamentals (although it’s always good to take a look at price-to-sales, debt, and other important metrics before buying a stock). In this case, we mean cheap goods sold by discount retailers. When consumers are stretched thin, cheap stuff rules the roost. Don’t believe me? Just look at yesterday’s drop. As of 4:00 p.m., only one Dow component had posted a gain: Wal-Mart. For the small-capper, screen for retailers with market caps less than $1.5 billion and you should find some interesting plays related to this idea. And for this screen, avoid specialty retailers and stores that primarily sell big-ticket items.

• During tough times, sin wins… Sin stocks are the comfort food of troubled times. A consumer who recently lost his job probably isn’t going to go out and buy a new car. But by the same logic, he isn’t going to give up his beer and cigarettes, either. In fact, the best performing stocks during past recessions have been tobacco and alcoholic beverages.

• Find the necessities. We’ve already talked about the top two recession gainers from the chart above. But what about household products? Yes, families are cutting back. But we seriously doubt they’ll stop buying toilet paper and bleach just because they’re stretched thin. There are plenty of items every family can’t live without. Companies that make the goods should do just fine…

Best,
Greg Guenthner

February 18, 2009

Three Steps to Turn a Profit in This Recession was originally featured in the Penny Sleuth.

A single company – one you’re probably familiar with – sold all three seemingly unrelated products. A few years ago, Sara Lee Corp (SLE:NYSE ) – maker of frozen (yet tasty) pies and cakes – owned hundreds of brands, many of which made no sense.

For instance, the frozen cheesecake manufacturer was the sole owner of Coach handbags and Hanes underwear. These two subsidiaries obviously didn’t make much sense to the company. That’s why – during two separate transactions – Sara Lee’s management and board of directors divested them through a process known as a spinoff.

Spinoffs are common in the business world. They can present smart investors with huge opportunities and sometimes, less fortunate investors with even larger losses. Spinoffs are usually as simple as they sound – a parent company decides it can do without one of its business. So, the subsidiary is spun off onto its own.

There are four basic reasons for a parent to spinoff one of its “children”:

• Unrelated Businesses – many times, companies like Sara Lee own certain subsidiaries – like Coach and Hanes – they have no business owning. This happens often in conglomerates when a certain product takes off and is held back by the organization of the parent company.

• Tax Benefits – taxes can be burdensome and confusing. But every once in a while, the mathematicians and financial wizards find a loophole to save on taxes and preserve shareholder value. Occasionally, it takes a spinoff to do it.

• Refocusing – oftentimes, a large company will take a look at its operations and find one of its businesses lagging behind, which inevitably puts a strain on management to fix the problem. The best solution is to spinoff this business so management of the parent company can get back to growing profitable businesses. This often benefits both the parent and “child” company.

• Pinching Off Debt – some spinoffs are created to unload debt and other burdensome liabilities. This is where many unfortunate investors take enormous losses. As you can imagine, a company created out of a need to unload debt is doomed from the start.

It’s important to decipher between the four reasons because if you find the right one, you stand to make colossal gains. Let’s look back at our top example…

As we noted, Sara Lee’s situation fits the first mold – unrelated businesses. Spinning off a perfectly capable business creates earning potential neither the parent nor the “child” even realized.

Sara Lee first spun off Coach in 2000. Almost immediately, the newly formed Coach Inc (COH:NYSE ) began its own marketing program. This turned into an enormous success and unrealized profit potential came to light, which shot shares straight up over the next six years. As you can see in the chart below, Coach outperformed its former parent by more than 2,000% to negative 15%.

The same thing happen in round two, when Sara Lee spun off Hanesbrand Inc (HBI:NYSE ) in 2006. Although the gains were not as fantastic, Hanes shareholders watch their shares double as Sara Lee shares stayed flat:

Of course, not all spinoffs work this way. It takes serious studying and an ear to the ground to find out exactly what’s going on.

Many times, when parents spinoff businesses, they keep it quiet. If the media gets a hold of it, shares can crash artificially, or spike prematurely. And, as we mentioned, many spinoffs negatively affect shareholders.

One recent example is InterActiveCorp’s (IACI:NASDAQ ) spinoff of Ticketmaster Entertainment Inc (TKTM:NASDAQ ) . When Ticketmaster was sent on its way, InterActiveCorp left it with a parting gift of about $750 million in debt, just as the credit crisis began to peak this summer. Shares of Ticketmaster, inevitably collapsed under this weight, falling more than 80 %:

Of course, you have to use your best judgment when you discover a spinoff. You’ll have to make the decision on why you think the parent company spun it off.

More than not, however, buying spinoffs when they’re fresh is a pretty good idea. According to Chris Mayer of Mayer’s Special Situations – a newsletter focused on spinoffs and other unique investments – “spinoffs beat their industry peers and outperformed the S&P 500 Index by about 10% per year in their first three years of existence.”

Those numbers account for both spin offs that lead to gains and those that lead to losses. Obviously, this is something to look into.

If you are lucky enough, and have the right inside knowledge, you can easily take advantage of the next Coach spinoff and leave the next Ticketmaster alone.

Sincerely,
Jim Nelson

December 18, 2008

Spinoff Stocks: Quick, Proven Way to Grab Easy Gains was originally featured in the Penny Sleuth.

“When you look back over the last 10 recessionary environments, what tends to lead back on the upside is small-cap equities.”

— William Greiner, Chief Investment Officer of UMB Asset Management

“Like springtime crocuses, small-cap stocks flourish once the harsh cold of a bear market is over… Because small-caps are undervalued once the market turns around, they benefit disproportionately from an earnings recovery.”

— Larry Light, Wall Street Journal

As investors scour the market for stocks that will be the quickest to bounce back once the market recovers, they need look no further than the small-cap sector. Penny stock gains outpace the blue chips on average during a rising market. Take as an example, the brief rally that occurred earlier this week…

In the rally that started Friday afternoon and continued throughout Monday’s close, it was the small-cap stocks that led the charge. In no way am I saying that the market has finally found it’s bottom, but it’s a nice reminder that small-cap stocks have historically led the way out of bear markets.

As you can see in the chart below, from 2 P.M. last Friday through the market’s close on Monday, the Dow gained 10.72%. During that same timeframe, the Russell 2000 Index gained 14.57% and then S&P Small-Cap 600 gained 13.83%.

It only seems fair that the small-cap sector would see a bigger bounce since the penny stocks have taken a brutal beating during the past few months. Over the past three months, the Dow has lost around 26%, while the Russell 2000 and S&P Small-Cap 600 both fell a staggering 39%.

Heading into bear markets, penny stocks have historically fallen the harder and faster than the large-caps. As investors get skittish, they often flee to the perceived safety of the blue chips and let the penny stocks fall by the wayside.

The small-cap stocks, however, are also the quickest to rebound once the market reverses course. As the bear market comes to an end, the penny stocks get the biggest bounce as earnings recover and valuations return to more logical levels.

As the market sentiment becomes more bullish, investors are attracted by the profit potential of the more speculative penny stocks, and they often leave behind their diluted positions in large-cap stocks and low-risk bonds.

That being said, now is a great time for small-cap investors to load up on cheap penny stocks. There are severely undervalued stocks strewn about the small-cap sector and savvy investors can grab some great deals right now. Once the market finally begins to recover, these investors will see the quickest gains and the biggest profits.

Best regards,
John Schuler

November 26, 2008

Small-Caps Lead the Charge in Most Recent Rally was originally featured in the Penny Sleuth.