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Buy These Oversold Stocks Before the Snapback Rally

Posted
7/2/2012 11:30:00 AM
By: David Sterman
Referenced Stocks:CWTR;FOSL;ODP;TTWO;ZQK

We've rarely seen such symmetry in stocks. In the first quarter of 2012, stocks zoomed ahead, almost to the very day that the quarter ended. Indeed, the S&P 500 hit its high mark for the year in the first trading session of the second quarter, and has been on the down slope ever since.

At this point, it's hard to understand that the major indices are actually higher than when the year began. It still seems like it's been a lost year. Still, for a number of individual stocks, the warm memories of the first quarter are long gone. More than 100 of stocks in the S&P 400, 500 and 500 are down more than 25% in the second quarter, and 28 of those are off more than 40% -- in just one quarter!

Unfortunately, it may be quite a few quarters until some of these stocks are able to regain some of the lost ground. Once a stock falls out of favor, it can stay out of favor as burned investors steer clear. Yet as I combed through the list of second-quarter, I spotted some real bargain stocks that might snap back in short order.

Take a look at this list of some of the second quarter's big losers...

Steer clear of retail
Other laggards such as fast-sinking retail stocks may stay out of favor for the rest of this year, even if they hold solid long-term upside. As a result, you may want to steer clear of Coldwater Creek (Nasdaq: CWTR ) , Quiksilver ( NYSE : ZQK) , Fossil (Nasdaq: FOSL ) and Office Depot (NYSE: ODP ) , all of which have fallen more than 40% in the second quarter.

I've recently touched on other stocks that have fallen 40% or more in the second quarter that have solid rebound potential, including Allscripts (Nasdaq: MDRX ) . [ Read that article here .]

I also recently suggested that Take-Two Interactive (Nasdaq: TTWO ) and Polycom (Nasdaq: PLCM ) were potential 100% gainers for patient investors in this article .

Looking for value in the oil patch
The sharp plunge in natural gas prices over the past 18 months, and the more recent drop in oil prices, has led investors to reduce their exposure to the energy sector quickly. A number of key stocks fell 25% or even 30% in the second-quarter, with Forest Oil (NYSE: FST ) , Swift Energy (NYSE: SFY ) and PDC Energy (Nasdaq: PETD ) all falling more than 40% in just the second-quarter. 

A rebound in these stocks will only come when energy prices firm up. Until then, their quarterly results may continue to weaken as hedges for future energy sales start to wear off and results reflect current lower energy prices. That's why I'm focusing on another industry play that isn't directly exposed to the underlying commodity prices. It's off 47% in the second quarter, but is now shaping up to be a clear value play.

Basic Energy (NYSE: BAS ) , which has more than $1.2 billion in annual sales, provides a wide range of equipment that energy drillers use, from the rigs themselves, to all of the tankers and other trucks that are used around a drilling site. 

The recent fall in energy prices is crimping demand and pricing somewhat, which can be seen in quarterly profit results. Earnings fell from $0.66 per share in the third quarter of 2011 to $0.58 per share in the fourth quarter to $0.50 per share in the first quarter of 2012. Analysts expect earnings to keep sliding in the near-term, to around $0.40 per share by the fourth quarter. That works out to be an annualized rate of $1.60 per share, which is a clear drop from the $1.87 a share earned in 2011.

Still, does that justify a downward move from the $37, 52-week high to a recent $10? Put another way, should this stock deserve to trade at its current multiple of three times projected 2012 EBITDA ?

Insiders don't think so. They started buying shares in late March when the stock had fallen to $17, and they've been buying at ever-lower levels since then. In all, these insiders have snapped up $5 million in stock.

Still, it pays to see how companies like this perform throughout a cycle to be sure that results won't turn disastrous. Basic Energy appears to hold up well regardless of strong or weak energy prices. The company has delivered positive free cash flow in five of the past six years (at an average of $55 million in positive free cash flow per annum). The only down year, 2010, saw negative free cash flow of just $14 million. Despite the current challenges, management believes the company will generate solid free cash flow this year as well. Though that 52-week high of $37 seems like a stretch, there's no reason this stock can't bounce from a recent $10 back to $15 or even $20 once quarterly results stabilize, perhaps by year-end.

Risks to Consider: These stocks, as a group, may remain out of favor until they can deliver a series of solid quarters.

Action to Take --> Many investors avoid these stocks because they lack timeliness , but some look so sharply oversold that value investors will likely start buying before the growth crowd returns. Basic Energy, along with the other stocks noted above, should be on your list of stocks for further research right now, before the snapback comes.


-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.