There is a clear downside to the impressive
bull market
we've seen during the last 22 months: it's getting harder and
harder to find real bargains. To ferret out value plays, investors
are increasingly turning to stocks that have lagged the market,
hoping to find
turnaround
candidates. One fertile area for research is the
IPO
market, where mediocre newly-public companies can see their
shares
fall sharply because of their relative anonymity.
I've looked at the class of 2010 IPO market on a number of
occasions, but what about the class of 2009? There must be some
unloved and undersold names populating this group of stocks. So, I
decided to take a look at the 2009 IPO market's worst performers. I
narrowed the list to include stocks off at least 30%, yet I also
wanted to focus on companies that are expected to see sales rebound
at least 10% in 2011. The stocks should ideally sport single-digit
price-to-earnings (
P/E
) multiples (though I made a couple of exceptions). I will then
discuss why some of these stocks have been so sharply
dismissed by investors. Later, I'll suggest the best rebound
candidate of the group.
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Guilt by association
When a company sporting a similar name is accused of
accounting
fraud, you know investors are likely to tar you with the same
brush. Shares of
Duoyuan Global Water (NYSE:
DGW
)
plunged more than 40% in September 2010 when
Duoyuan Printing (NYSE:
DYP
)
owned up to some accounting problems. The two companies are
unrelated except that they have the same chairman. Duoyuan Global
Water makes a range of filtration products, water softeners and
ultra-violet sterilization equipment. It's not a sexy business, but
in light of China's myriad water quality issues, demand for the
company's products and services is reasonably robust. [My colleague
Andy Obermueller, editor of
Game-Changing Stocks
, says water is
even more valuable to China than oil
.]
To clean up its tarnished image, Duoyuan Water recently hired
auditing firm Grant Thornton. That's a wise move and one that is
likely to be followed by many Chinese firms that currently are
mistrusted by U.S. investors.
Shares of Duoyuan Water have fallen from $40 to $12.50 during the
last 15 months and certainly look quite cheap on a
price-to-earnings (P/E) basis. However, investors looking to play
the China water clean-up might be better off sticking with
Tri-Tech Holdings (Nasdaq:
TRIT
)
-- which has jumped 20% in a matter of days
since Andy mentioned it
. The stock was also a 2009 IPO that lagged in 2010 -- but is
showing signs of a continued rebound in 2011. [For a more detailed
look at Tri-Tech, see my
Top 3 Chinese Stocks for 2011
].
Lots of promise and lots of frustration
With electric and hybrid cars moving into the spotlight, you'd
think that battery maker
A123 Systems (Nasdaq:
AONE
)
would be a hot stock. Well, it was when it first went public, but
shares really hit the skids in 2010 as investors realized the
advanced battery market would be slow to materialize.
But A123 is starting to benefit from the trend -- sales are likely
to more than double this year -- but it will still be several years
before the company can generate positivecash flow . That means that
it will likely need to raise more money. I like this
company'sbusiness model , but you're best off keeping this stock on
your watch list until the capital-raising efforts have completed,
which may happen in coming quarters.
Pain now, gain later
The health care industry is going through a host of wrenching
changes, as reimbursement schemes come under pressure and major
players sort out their business models to adjust to rising cost
pressures and falling revenue. Over time, industry analysts expect
a balance in supply and demand, and, consequently, a between
revenue and expenses, will strike. In effect, they expect income
statements to remain under pressure in 2011, but conditions to
return to normal in 2012 and beyond are good-- especially for
treatments and services that are vital and cost-effective.
That issue surely applies to
Select Medical (NYSE:
SEM
)
, my favorite pick of the group. Select is the leading provider of
Long-Term Acute Care (LTAC) services. Many chronically ill patients
need this kind of specialized service and demand is only likely to
grow as our society ages.
But right now, Select Medical is a victim of lousy timing. A 2009
IPO was followed by a subpar 2010. And the company should see only
slowly improving results in 2011. Even though insurers reimburse
many LTAC services, other services aren't covered and the economic
downturn has led to a sharp pullback in this large out-of-pocket
expense. But as theeconomy improves, so should utilization at the
company's 111 LTAC centers and six LTAC rehab facilities. As a
result, the outlook for 2012 and beyond is likely to improve on the
heels of a rebounding
economy
.
Meanwhile, Select's shares are off 30% from the September 2009 IPO,
which has led management to initiate a hefty $100 million stock
buyback that could reduce the share count by about 10%. As long as
shares remain below $8, management is likely to keep buying back
stock throughout 2011.
Analysts expect revenue to rise about 15% in 2011, about half of
which is coming from acquisitions. That should help sustain the
company's strong level of
cash flow
, which could approach $400 million this year. Shares appear to
have minimal downside at this point because they have already
absorbed a litany of challenging operating factors in 2010. Trading
at around six times the projected 2011 EBITDA, shares look to have
roughly 30% upside as they move closer to historical multiples.
Action to Take -->
In a market now dominated by ever-rising P/E ratios, you have to
look deeper for cheap stocks. Select Medical is my favorite name on
this list, but the others certainly merit consideration.
These companies have had forgettable years in 2010, but much of the
bad news appears to be in the past for many of these names. Low P/E
ratios could help boost their profile among value investors in 2011
and lead to rising share prices.
-- David Sterman
We've just identified six surprising events that could break
your portfolio wide open in 2011. Knowing these pivot points in
advance lets you focus your investing strategy like a beam of light
in the dark... and make a lot of money in a hurry. Get them free by
simply watching this video presentation.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.