Three More Long Shots for the Bold Investor

 | Mar 02, 2012 | 2:30 PM EST  | Comments
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Stock quotes in this article:

rad

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fch

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dxyn

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rdi

After writing my column yesterday, I spent some more time thinking about long shots. Stocks that have an upside of many times your purchase price can build wealth quicker than the typical Wall Street approach of looking for stocks that can rise 20% to 30% on the basis of some combination of earnings growth and multiple expansion.

To accept all the market, financial and geopolitical risk in order to own something that will go up 25% if everything goes right has always struck me a dumb way to invest. I want to think like a business owner and own something that will increase my wealth by a factor of at least four or five over time.

In addition to using the classic value techniques to find these situations, I also like to feed my inner vulture form time to time. As I said yesterday, if I were in my 20s and had it all to do over again, I would focus entirely on long shots, and a big part of that would be distressed stocks and securities.

Companies that have stumbled financially will either continue to fall into oblivion or rise like a phoenix over time. A few, such as RiteAid (RAD), will linger in the abyss for years, even decades, but most will recover or die. Finding the ones that can recover can make you wealthy. Again, a batting average of over 50% is going to outperform just about every fund manager and investment vehicle over a reasonable period of time.

Every once in a while, I like to feed my inner vulture and search for some distressed stocks that have the potential to recover and pay off in a spectacular fashion. I run a screen for companies that have more debt than equity that are trading below book value and are priced in the single digits. I then run them through some basic credit scores and evaluate their underlying business and recovery potential. From time to time I turn up some real gems that are worth further investigation and investment.

Looking at the screen I ran this morning, I see some stocks that are not only worth considering, I already own them. I have had a nice return in shares of FelCor Lodging (FCH) since the first of the year, but that's a percentage, not a multiple. The company has been selling hotels in suburbs and airport locations and plans to use the cash to pay down debt and catch up on the $76 million in preferred dividend arrearages it owes. The hotel market has been firming as room rates and occupancy levels rise, and this company could well be on the verge of a long-lasting recovery. If it succeeds in managing the balance sheet while a recovery blossoms, these shares could grow by many multiples of the current price.

Another old favorite is on the list as well. I have lost track how many times in my career I have owned a stake in Dixie Group (DXYN). I do know that I have owned just about every publicly traded security it ever issued at various times over the past 20 years. The company makes carpets for the residential and commercial markets, and as you can imagine, business has suffered during the slump. The company has recently improved its balance sheet by negotiating a new line of credit and repaying some higher-coupon debt. The stock has improved in recent weeks but still has a long way to go to get near the pre-crisis highs.

Reading International (RDI) is another company I have owned before and may well add to my long-shot portfolio soon. The movie business is picking up along with the economy, and the company is seeing improvements in cash flow. More importantly, the stock trades at a discount to book value that is probably substantially understated. Reading International has owned its properties in New York and Chicago for a decade or more. The same is true of many of its New Zealand and Australian properties. In addition, Reading has net operating loss carry-forwards in all three nations where it operates theater complexes. Reading International has a lot of moving parts, including currency translations, but it appears to own a lot of assets that are priced at a substantial discount to their realizable value.

When searching for distressed and vulture equity situations, it is very important to realize that the screen is just the starting point. You need to run the credit scores and tests and really drill deep into the business and assets of a distressed long-shot company. However, the current list has some stocks that could well provide a return that will be measured in many multiples of the purchase price.

Speaking of long shots, I just found out this morning that a horse named I'll Have Another is in the Kentucky Derby futures pool at 29-to-1. I don't think I can resist.

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