Buying Hated Stocks Works

 | Dec 03, 2013 | 2:00 PM EST  | Comments
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Stock quotes in this article:

fnma

,

fmcc

,

amr

,

rad

,

svu

,

wfmi

,

wmk

,

cvx

,

wag

,

tecua

,

bac

With 2013 all but over, it may come as a shock to many that the year's best investment opportunities were companies that were widely regarded as being subpar businesses with no chance of survival. More so, these businesses were viewed as possessing low-quality assets that were likely to produce inferior returns on capital.

Topping the list are two names more people are now starting to pay attention to -- Fannie Mae (FNMA) and Freddie Mac (FMCC) , up over 800% and 700% so far this year, respectively. Both of these entities are pulling in record profits thanks to a rebounding demand for mortgages.

Up nearly 900% this is AMR Corp. (AMR), parent of American Airlines. Up nearly 300% is drug store chain Rite Aid (RAD). Up nearly 200% is supermarket chain Supervalu (SVU).

From the looks of it, there appears to be nothing positive that a highly leveraged airline, grocery store, drug store chain, and buyer of mortgages have in common. What they all seemingly have in common is that they indeed possess less than stellar assets when stacked up against many of their peers.

Why invest in Supervalu when you have names like Whole Foods (WFMI) and Weis Markets (WMK)? Why touch Rite Aid when you have CVS (CVS) and Walgreen (WAG)? Why invest in any airline or a government owned mortgage finance firm?

The answer is both counterintuitive and rational: The price paid dictates the value you will get. Stated differently, a low quality asset can be a far superior investment candidate than a high quality one. The determining factor is the underlying price one pays for that asset. And with the five businesses above, they began the year trading at prices that basically assumed the equity was worthless.

To be clear, hindsight is a beautiful thing. I never came close to making a single one of these investments. It would have been an easy and intelligent argument to make that these companies were highly speculative bets rather than value investments. On the other hand, I did enjoy owning other bargain opportunities like Tecumseh (TECUA) and Bank of America (BAC)when both were trading in the low single digits.

Great investment opportunities come about when companies are experiencing a period of distress. You won't find more attractive price points. That being said, for every home-run stock, there are probably a bunch of strikeouts as well. You have to do the legwork. But given the potential return outcome, the time and effort is well worth it. Stay tuned for some distressed names that could have a standout year in 2014.

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