Losing to Win

 | Oct 01, 2012 | 4:00 PM EDT
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One of the more interesting studies I have read over the years involved larger companies that are currently losing money. It seems that these companies usually manage to right the ship and begin producing positive earnings once again. When this happens, the stocks of these corporations tend to explode to the upside and outperform the broader market by a comfortable margin. When I reviewed the data recently, I found that the stocks with the greatest outperformance were those that were not egregiously priced on positive forward estimates. Although I put little faith in the accuracy of analyst estimates they do usually manage to get the profit or loss distinction correct, so it is relatively easy to screen for these potential winning stocks.

I set up a screen to look for companies that are losing money over the past 12 months and are expected to turn the corner next year and show positive earnings. I then filtered the list for those companies that trade at modest forward PE ratios. I allowed for some wiggle room in the forward POE as I put very little value on the accuracy of analyst estimates. Further, the companies that exceed the expectation by a high percentage will likely to be the best performers. The filter was set to look for those stocks trading at less than 15x the estimated earnings for the next year.

The largest company on the list is one that has been a value trap for some time now. Investors have thought Hewlett-Packard (HPQ) to be cheap for more than a year now and it just keeps getting cheaper. After the disastrous second quarter with one-time charges of $5.49, the company is showing a substantial loss for the past year. Analysts are pretty lukewarm about the prospects for Hewlett but the company is still expected to show a profit over the next 12 months. The company has an analyst day Wednesday that could give us a better look at management's expectations and CEO Meg Whitman's plans for turning the company around. If the company were to hit the lowest estimate of all the analyst the stock is trading at less than 5x earnings. A lot of smart value and activist investors have been buyers of the stock this year, so it is probably time to consider adding this stock to long-term portfolios.

Private equity giant Blackstone Group (BX) is also showing a trailing 12-month loss and is expected to report profits over the next year. I loved the private equity business back in 2008 and am warming toward it once again. Although shareholders do not participate directly in the firms deal-making, they do enjoy the lift from the earnings in the form of percentage deals that Blackstone stands to make over the next few years. The firm is investing in real estate, natural gas and other beaten-down sectors of the economy that could see huge returns in an eventual economic upswing. Led by the 412 billion global real estate fund assets under management have been rising, growing by 22% in the last year. Analysts expect another 20%-plus surge in fee earning assets next year.

I have also been warming to the idea of the gold miner stocks in recent months. I have no interest in gold as a hedge or speculation in the end of the world but many others do have such interests and beliefs. Together with jewelry and industrial need from a gradually improving global economy, this demand for the shiny stuff should make gold mining a pretty good business going forward. Kinross Gold (KGC) has shown up in the portfolios of some noted value investors, including Third Avenue and Passport Capital. It makes our list as well because the company is showing a loss for the past 12 months. But the company is expected to be profitable and start growing again over the next year. The company has been shedding non-core lower production assets to focus on properties with more production growth potential. As long as gold remains relatively firm or appreciates further, this should produce substantial top and bottom line improvements for Kinross.

The idea of buying stock in companies that are currently losing money but are on the verge of a turnaround is intriguing. I intend to spend some more time crunching numbers and looking for ideas using this approach.

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