Shopping the Growth Investors' Garbage

 | Jul 25, 2014 | 3:00 PM EDT
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In December 2012, I grabbed an edition in Investor's Business Daily (IBD) and practiced a rousing game of invert based on the theories of Carl Jacobi that Charlie Munger is so fond of quoting. Instead of looking for stocks that meet the IBD criteria (high earnings growth and relative strength), I looked at names that had the lowest composite rankings in the paper's stock table.

These stocks had no momentum and the company's earnings were lousy. I ran across that column yesterday and the results of the reverse approach worked pretty well. In less than two years, the three stocks, Tronox (TROX), Alleghany Technology (ATI) and Sony (SNE) had an annualized return of about 42%.

Last night, I grabbed a recent copy of the paper and a highlighter to see which stocks currently have single-digit composite ratings from the paper. Again, I am looking for stocks that no one likes -- everyone is selling them and they have no positive short-term earnings momentum. I am basically shopping the growth investors' trash can in search of ideas.

The first stock on the list made me feel pretty good about chances for a repeat performance. International Shipbuilding (ISH) is a U.S.-based shipping company with 50 ocean going vessels. They carry coal, sulfur , cars and trucks and rail cars around the world. Nine of its vessels are flagged as Jones Act carriers which allow them to carry cargo between U.S. ports. The stock is very cheap, trading at just 50% of book value, and, as a bonus, it has a generous 4.57% dividend yield. I own the stock and am buying more on this most recent selloff.

One of the more interesting companies on the growth stock garbage list is CGG SA (CGG) out of France. The company provides geological, geophysical, and reservoir services to customers in the oil and gas exploration and production industry. Business has been slower than expected as oil companies have put off additional exploration activities but it is only a matter of time before this changes. The easy oil has been found for the most part and oil companies are going to have to utilize the tools CGG provides to find new fields. Management has been reducing the fleet in an effort to focus on the most profitable segments of the business and this should pay off when business begins to pick up again. The stock is down more than 50% in the past year and could be past due for a rebound.

One of the worst stocks according to the IBD rankings is Embotelladora Andina S.A. It has the lowest possible composite ranking and a relative strength reading of just 7 on a scale of 1-100. The company has a great business as they produces, markets, and distributes Coca-Cola (KO) soft drinks in Chile, Brazil, Argentina, and Paraguay. The company also markets fruit juices, energy drinks and several beers, including the Amstel, Bavaria, Dos Equis (XX), and Heineken brands. Since hitting highs around $40 in 2013, the stock has fallen by about half and nobody seems to like it very much. The company is the second largest Coke bottler in South America and the seventh largest in the world. I suspect the stock will be a lot higher several years from now.

magicJack VocalTec (CALL) has been growing at a nice rate with an average of 25% earnings gains annually for the past five years. magicjack is a cloud-based communications company that provides voice-over-Internet-protocol (VOIP) services in the U.S. I have one and so do several of my friends who travel a lot because it allows you to turn your computer into a portable home phone.

Short sellers don't believe the company can continue to generate consistent profits so they have been hammering away at the stock. More than 40% of the float is sold short so it would not take much in the way of good news to see a short-covering rally in this stock. As the new magicjack GO product reaches more of the big-box stores this year, we could see that happen with sharply higher stock prices as a result. You will almost never hear me say this, but it is probably worth buying a few out-of-the-money January 2015 $15 calls as a pure bet that the shorts have it wrong. It's the equivalent of a trip to the track with an underbet speed horse moving on in class. It might not work but if it does, it will pay really big.

My last experiment with IBD inversion worked pretty well  and I have every reason to think this list could do just as well for patient investors.


At the time of publication, Melvin was long ISH.

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