More Long Shots for Your Portfolio

 | Oct 20, 2011 | 1:25 PM EDT  | Comments
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It may come as little shock that I spent last night watching the first game of the World Series. As the world's last die-hard baseball fan, I love the pageantry and excitement of the series. Thanks to Texas being in the Fall Classic this year, my wife did not mind as much as she usually might, and I was not relegated back into the office for my baseball viewing.

The real story of this series of course is the Cardinals of Saint Louis. In August, they were more than 10 games out of the wild card, never mind the division lead. They were written off by most before these long shots made a furious charge, and they are now playing for the whole enchilada. Thinking about this led me to reflect on yesterday's column on stocks in the Value Line universe that are long shots and which have high potential returns if the companies survive and recover.

Although investing in a portfolio of long shots flies in the face of conventional wisdom, the math of this approach can be compelling. If you can do as well as a coin flip and half of your picks reach their potential and half of the remaining companies just stay in business, you would beat the market return over time. If you do better than that, you could easily blow it away by more than 50% over time. This approach has risks, but so does any form of investing. The key would be to have a diversified portfolio of carefully researched picks that have the potential for extraordinary returns in the event of a full recovery.

I outlined two such stocks yesterday, but you need more than that to build a portfolio of long shots. I looked over the full list of stocks and have identified some that might fit the bill. Some even fit into two of the stronger long-term investment themes, and this might give them a greater chance of long-term success as the economic tides shift in their favor.

The first is, of course, banks. This is the group everyone loves to hate right now. They face significant headwinds from all directions, and the stock prices reflect this turmoil. When I look at the Value Line list of stocks that have high potential for recovery, I see that the two most maligned big banks make the cut. I am not a huge fan of either Bank of America (BAC) or Citigroup (C), but if they continue to receive de facto government support and if the global economy begins to recover, these stocks could easily sell many multiples higher than the current quote over the next five years.

The same is true of Bank of New York Mellon (BK), another bank that makes the list of long shots. Two regionals that are troubled by credit losses, Regions Financial (RF) and Synovus Financial (SNV), are on our list. If they manage their credit losses and expenses, a recovery in real estate markets could send these stocks soaring to many multiples of the current prices over the next five years.

The other investment theme with representation on the long-shot list is infrastructure. I am not sure when it will happen, but infrastructure spending will occur at some point in the U.S. A weak economy and reduced revenue for state and local governments have delayed the needed spending, but the work is needed. Repair of the nation's water systems, electrical grid, roads, highways and bridges is going to be a high priority when the economy recovers. Companies that do this work and supply the materials will see rapid growth in revenue and profits for an extended period of time.

Cemex (CX), based in Mexico, is a long-shot recovery candidate for this reason. The over-leveraged cement and aggregates company has struggled in recent years. A slowdown in highway building and construction in the U.S. has hurt its revenue in the past few years. The company has recently taken steps to pay down its debt, but if business does not pick up soon, the possibility of debt-covenant violations still looms. Cemex has no debt maturities until late 2013, but more than $8 billion matures in 2014, so it needs to develop a solid plan to refinance or extend those debt maturities. If the company is successful in managing the debt, this stock could sell for many times the current quote five years from now.

Insituform Technologies (INSU), a pipeline repair and rehabilitation company, has also struggled in recent years. The slowdown in municipal spending has caused the company's U.S. business to slow substantially. The company has been active on the acquisition front to diversify outside the U.S. As spending in the infrastructure and energy markets returns to more normal levels, Insituform's earnings and stock price should experience a strong recovery.

Long-shot investing is not for everyone. If you are willing to do the homework and can stomach the volatility, it could be a rewarding approach to stock market investing for long-term aggressive investors.

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