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3 Unloved Stocks Poised for a Major Rebound

By: David Sterman
Posted: 2/29/2012 11:30:00 AM
Referenced Stocks: CAR;CREE;DGIT;EPS;HTZ

Earnings season can be a white-knuckle affair. You wait on pins and needles to see if your stocks deliver solid results and a robust forward outlook. So when results roll in and they are disappointing on most counts, it's quite tempting to just dump the stock and move on.

Yet for many investors, a weak quarter spells opportunity.

By digging past the headlines and deciphering what lies ahead, as spelled out by management plans, these tough periods can simply present buying opportunities -- assuming the stage is set for better results in the quarters to come.

I call these the "bad quarter, good outlook" stocks.

The subsequent quarter may also be challenging for these companies, but if you are willing to hold a position for several quarters, then your patience may be rewarded -- handsomely.

A clear example can be seen with Cree Inc. (Nasdaq: CREE ) , which is a member of my $100,000 Real-Money Portfolio . The maker of LED lighting systems missed analysts' fiscal second-quarter sales and profit forecasts. And though shares opened down nearly $1 on the morning of Jan.18 to below $23, they've risen nearly 35% in the ensuing six weeks. Why? It's because investors sense that Cree will eventually deliver much improved results -- perhaps not in the current quarter, but soon enough.

Here are three other companies that recently delivered disappointing results, but should be very appealing to long-term investors.

1. Avis Budget (NYSE: CAR )
The world's second-largest car rental agency (after Hertz (NYSE: HTZ ) ) lost $0.14 a share in the December quarter. Analysts had been anticipating a $0.06 a share profit. Part of the loss can be attributed to costs associated with a September 2011 purchase of Avis Europe, which had been divested more than a decade ago.

It's actually that European acquisition that spells upside for Avis Budget in the quarters to come. Management has identified a range of cost-cutting opportunities in what has been a fairly bloated European operation. In addition, combining on all of the company's regional divisions onto one platform should yield solid cross-selling opportunities: Corporate customers tended to give most of their business to Hertz simply because it was easier to negotiate world-wide terms with just one vendor. Avis' management team will be pushing hard to boost the company's presence among corporate accounts in the quarters ahead.

Analysts have yet to incorporate any of the cost cuts or potential revenue gains as Avis Europe is integrated. The company's earnings per share ( EPS ) is expected to be flat in 2012 at about $1.60 a share (compared with $1.65 a share in 2011), with EPS rising to just $1.70 in share in 2013. Yet the revamped Avis looks capable of earning around $2 or $2.25 a share once the planned move take place.

Shares had risen up above $15 in early February on hopes of a strong quarter. They're now back below $13, or around six times my projected 2013 earnings , as the bar has been re-set.

2. Digital Generation (Nasdaq: DGIT )
This provider of broadcast and online media placement programs has missed profit forecasts for three straight quarters. Shares have fallen from $37 during last spring to a recent $10.50. Yet a large part of the earnings weakness stems from heavy investments in the company's key platforms.

Digital Generation, formerly known as DG Fast Channel, helps disseminate advertising and video content across broadcast networks. Although DG was also investing in a separate Internet-focused video platform, the company realized that the line between TV programming and Internet programming was quickly blurring as consumers increasingly sought to stream their favorite shows, movies and video clips. DG has been moving to quickly integrate its two business segments, creating a one-stop shop for advertisers and content producers.

To reflect those investments, management anticipates per share profits slumping about 25% this year to $0.67 before rebounding to $0.90 in 2013. Analysts have quickly moved to the sidelines, with several lowering their rating to "neutral." That's OK. They'll likely look to upgrade shares again AFTER the company is once again on a healthy growth path. Long-term focused investors should be researching this bounce-back candidate before the analysts come back around.

3. Calgon Carbon (NYSE: CCC )
This maker of carbon filters used in air and water purification systems warned in mid-February that a series of one-time charges would dampen fourth-quarter profits. Analysts expected the company to earn $0.19 a share in the quarter prior to that warning, and the company ended up earning roughly half as much.

Yet Calgon Carbon is pursuing a range of initiatives that could sharply boost sales and profits in the years to come. So management has decided to boost spending now, dampening near-term profits. Those growth initiatives include:

• Increasingly stringent mercury emissions at coal-fired power plants, many of which will need the company's scrubber technology.

• New marine regulations that restrict ships from dumping dirty ballast water. Calgon Carbon's Hyde Marine division makes filters that have proven quite effective in scrubbing water impurities out of these discharges.

Analysts at Brean Murray have a straightforward explanation as to why investors should overlook recent weak results: "If we look at CCC's list of negative impacts in 4Q11, they are, in our view, indicative of the typical growing pains we would expect any company of CCC's size to experience that is actively expanding across multiple major platforms, each containing a unique set of opportunities."

Shares of Calgon Carbon have been stuck in a tight $16-$18 range for most of the past four years, though Brean Murray sees an upside move to $24 once the company's current investments have paid off.

Risks to Consider: A weak quarter can often beget another weak one, so it's best to stay focused on the long-term potential for these stocks.

Action to Take --> Remember that the strongest investment gains come from stocks that are unloved by most, usually due to recent operating trends, but are capable of stronger trends in the quarters to come. These companies surely fit that description.


-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of CREE in one or more if its "real money" portfolios.