Looking for Low-Cost Outliers

 | Oct 15, 2013 | 3:30 PM EDT  | Comments
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Sir John Templeton did it. Warren Buffett, back in the 1950s and 1960s, did it. Benjamin Graham, the father of value investing, advocated it. And countless others have done it at some point during their investment careers. The idea is simple: Buy beaten-down, trashed stocks that are trading for dollars or pennies, wait for the sentiment to change, and the result could be returns that are multiples of the original investment.

Call this a low-price stock strategy, investment or speculation -- whatever you wish. It's a method that works, it but can be costly. That's why it's best buying a little bit of many low-priced stocks (Templeton bought dozens) and hoping to parlay the winners to make up for the losers and then some. Templeton tripled his money, and Buffett -- well, we know how that worked out.

 The market selloff in 2008 proved this trade yet again. Saks (SKS) climbed to $16 from $1.55; Cheesecake Factory (CAKE) climbed to $43 from $5.50; Teck Resources (TCK) moved above $60 from $3 (the stock now trades for $27); and there are countless other cases. Of course, there are opposite examples: ATP Oil & Gas (ATPGQ), once a darling that traded for $50, now fetches $0.15. But consider the math: If you put $10,000 into each idea, one investment like Saks allows you to have several ATP's and still triple or quadruple your money.

The best time to make this low-priced stock bet is when there is chaos in the market, because the population of low-priced stocks is wider. In today's market, it's slim pickings, but some names could be performance outliers in the next couple of years.

Extreme Networks (EXTR) might be one. Shares trade for $5.50, it has no debt, and there is $1.50 in cash per share. The company's supplies networking and communication devices to the tech industry.

Quicksilver Resources (KWK) trades around $2.45. It's an oil and gas name with assets in high-quality regions like the Barnett Shale and Alberta.

Dendreon Corp (DNDN), a biotech company, trades for about $2.60. It's focused on treatments for cancer and is known for its prostate cancer drug Provenge. The company is seeking approval for this drug in Europe and the fate of that decision could be a make-or-break decision.

Martha Stewart Omnimedia (MSO) is a well-known name that is trying to reinvent itself recapture some its old glory when shares were trading north of $30. Today they are around $2.30.

RadioShack (RSH) is another name that has seen its value disintegrate and is seeking a turnaround. At $3 a share, this once well-established retailer is trying to find its niche in the highly competitive electronics marketplace.

The key to making any bet in these companies is to make many bets at smaller positions sizes. Make no mistake: some, perhaps many, of these low-priced stocks will eventually trade for pennies or go bust. But even a 100% loss can be overcome by a 300% gain. As the saying goes, you want to have many little eggs in your basket. Some will hatch into lovely chicks while others rot. But those that hatch will make up for the rotten eggs.

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