Kicking Over Rocks

 | Jul 05, 2012 | 11:30 AM EDT  | Comments
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Stock quotes in this article:

aeg

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pike

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hban

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key

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rbs

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elnk

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KTG

The Fourth of July is behind us, as is the first half of 2012. In the stock market, it has been quite a ride so far with high volatility and many news-driven gyrations delivering a return of about 5%. Today we see a battle shaping up between lower jobless claims, lower Chinese interest rates and more talk of European economic weakness. Each talking head on the tube has a different idea of what will happen in the second half of the year. I find that amusing since much of what happens depends on several unknowable factors, such as election results and what path Germany decides to take in Europe. Predicting the second half is like picking the World Series winner at the All-Star Break. I can give many plausible scenarios, but none are definite.

A far more productive use of my time is wandering around the corners of the financial markets kicking rocks and looking under bushes for cheap stocks. I do not feel like I can make an accurate prediction of where the market will close today or tomorrow but I can find companies that the market is overlooking or mispricing. Buying and holding these stocks until their value is recognized regardless of market movement has proven to be a profitable way to invest over the past few decades. I suspect it will be in the future as well.

As part of my rock-kicking this morning, I sat down and ran a simple screen looking for long-shot stocks that have the potential for huge moves over the next several years. I looked for low-priced stocks that received high ranking from Standard & Poor's research.  Using the research service's highest-ranked stocks as a starting point has been productive over the years, so I decided to apply to lower priced long-shot stocks and see what I found.

It is often said that a measure of a man's brilliance is how much he agrees with you and I find that the list contains many stocks I already own. I am already long Kite Realty, (KRG), AEGON (AEG), and Pike Electric (PIKE) in my own and clients' accounts. Regional Banks are well represented by Huntington Bancshares (HBAN) and KeyCorp (KEY). Even my favorite European bank is on the list as Royal Bank of Scotland (RBS) is among the ranks of low-priced, high-potential stocks.

Only four stocks in the Standard & Poor's universe trade below $10 and receive the service's top 5-star ranking for future performance. Twenty-six companies received the second-highest, or 4-star, ranking. One of the 5-star stocks is Huntington, one of my favorite larger regional bank stocks. The stock is almost a perfect bank stock as it trades below book value, has nonperforming assets of less than 2% and is over-reserved. If the equity-to-assets ratio was a little higher, HBAN would be bank stock perfection. If you do not own it, you should be a buyer on weakness.

Networking and communication company EarthLink (ELNK) is one top pick that would not show up on my ordinary stock screens. The stock doesn't trade anywhere close to book value. Although EarthLink is best known as a retail Internet provider, the company has grown the commercial side of the business via acquisitions and now derives 75% of its revenue from business accounts. Revenues are growing because of the acquisition activity and the company should see strong earnings growth for the next several years as it continues to expand its business Internet and Information technology offerings.

Looking for lower-priced stocks that have been overlooked by most of Wall Street can be a profitable exercise. Using an independent research service like S&P or Value Line to weed out the fundamentally unsound companies with poor prospects can make the job easier and more profitable for individual investors.

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