Playing the Long Shots

 | Oct 19, 2011 | 12:45 PM EDT  | Comments
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Stock quotes in this article:

luv

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ual

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fch

Usually in early April I feel the old familiar urge begin to bubble up, which is accompanied by the faint scent of really good bourbon. The only way to get rid of this lingering discomfort is to head to a racetrack, usually Keeneland in Lexington, KY, and spend an afternoon with the ponies. I look for the horse with longer odds; a horse that may have a condition that will lead them to victory. I look for the horse stepping down in class or the beaten favorites for nice, long odds where a small bet can pay for a long evening at DeSha's and McCarthy's.

On occasion I apply my long-shot search to the stock market as well. Walter Schloss once commented that he always liked to hold a few positions that were a little more speculative to keep things interesting. I think this is great advice. As much as horse-and-bourbon fever tends to hit in April, my desire for long-shot stocks tends to flare up when markets and the economy are weak, and confusion and uncertainty are at their highest. At such times, many beaten favorites and companies that have moved down in class can offer significant appreciation potential.

In order to find these long-shot stocks, I review the latest edition of my favorite research service, The Value Line Survey. Each week, they publish a screen of stocks with the highest total return potential. When looking for long-shot stocks, I want to find companies so beaten up and out of favor that they merely have to survive the current environment to see a price recovery .

Near the top of the current list are airline stocks. The global economy is still very weak, and the widening spread between crude oil and aviation fuel is making hedging difficult for many carriers. I have no interest in ever owning the legacy carries and I'm still short United Continental (UAL) and probably will be for some time. However, Southwest Airlines (LUV) has fallen to the point where the three-to-five year appreciation potential is enormous. The integration of Airtran is under way and should significantly expand revenues and profits for Southwest over the next five years.

Eliminating the overlapping services and support systems should provide enormous cost savings opportunities that could add as much as $400 million to the bottom line for the airline. Value Line estimates the stock could trade between $30 and $45 per share over the next five years. Tangible book value for this company is $7.82, and if it trades back below that level, this would not be just a long-shot stock, but a no-brainer stock that long-term investors should own.

A more speculative, but nonetheless intriguing, name on the current list is FelCor Lodging (FCH). The hotel operator currently owns interests in 78 hotels. Like many hotel operators, the combination of a weak economy and high debt levels has hurt the company as well as its stock price. The company has been aggressively selling it hotels in suburban and airport locations as well as smaller markets. Felcor has sold $145 million of properties in the past two quarters and has five more that should be sold by the end of the year.

The company has refinanced higher-rate debt and used proceeds from asset sales to reinstate the preferred stock dividends. If management is successful in restructuring the property portfolio and balance sheet, Felcor shares could have extraordinary return potential. Should management reinstate the common stock dividend over the next few years, the stock could easily appreciate back into the teens form the current sub-$3 level, in my opinion. I wouldn't bet the farm on Felcor, but buying a little at this point and accumulating shares as conditions improve could have a huge payoff for patient, long-shot investors.

Long shots should not be a huge part of your portfolio, but owning a few of these names keeps things interesting and could have a large reward over time.

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