Seeking Stock Picks Among the Unloved

 | Dec 17, 2012 | 2:00 PM EST  | Comments
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Stock quotes in this article:

TROX

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ati

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sne

This past weekend, I picked up a copy of Investor's Business Daily on a whim. I do not usually read IBD, as it is just not a value investor's paper. The articles and reporting are solid, but the paper is really designed for momentum and growth investors, and that is just not me.

I have researched IBD's CAN SLIM method of stock-picking and have even been to some of the seminars. I couldn't ever make it work for me, and it seems to have excessive turnover and seems to chase the darlings of the day. I find that to be a somewhat dangerous approach, but the paper and its founders sure have a lot of disciples.

Anytime the subject of stocks comes up, someone is sure to talk about cups and handles, bases and the composite rankings the IBD uses to measure stocks' attractiveness. I may not like the method, but a lot of people use it. As I sat reading through the paper, an idea occurred to me. As Sir John Templeton pointed out, the way to make money in the markets is to not do what everyone else does. If everyone else is chasing high relative-strength numbers and earnings momentum, what would happen if we looked for the lowest numbers in the paper?

I sat down with an old-fashioned pen and notepad and looked for stocks that had the lowest composite ratings and combined earnings and price momentum. Specifically, I looked for those below 10. My thought was that these would be the most unloved companies that had stumbled recently, and there may be some bargains that had enormous long-term potential. As it turns out I was right.

One of the first stocks I ran across was Tronox (TROX). The company makes titanium dioxide pigments that are used in wide range of products, such as paint, coatings and plastics. I have mentioned the stock before, and so far I have just been wrong about it. The company was spun off from Kerr McGee with excessive liabilities related to environmental issues, and it emerged from bankruptcy in 2011. As part of the reorganization, Tronox passed the liabilities to a special trust and emerged as a healthy, more competitive firm. Last year, Tronox bought a South African mineral sands operation that provided feedstock for titanium dioxide, allowing it to provide much of its own raw-material needs.

Ironically, the company received a very positive write-up in Barron's this weekend. I am in agreement with the author's assumption that this stock could easily double over the next year. The company is solidly profitable, and the stock is trading at 70% of tangible book value and yields 6%. Business has been weak as a result of global economic slowing, but any pickup at all will launch this stock. I don't own Tronox yet, but I will be buying this week.

Alleghany Technologies (ATI) is also a single-digit stock, according to the ranking system used in IBD. This company makes specialty metals for a wide range of industries. The shares have been weak, as its customer base includes some industries that are suffering from a weak economy, such as chemicals and aerospace. The stock is worth watching, since if we go off the fiscal cliff over the next few weeks, it could get hit pretty hard in a selloff. At that point, given the company's exposure to some potentially high-growth industries and presence in China, the stock could be a very attractive long-term buy.

A recent long-shot suggestion, Sony (SNE), also makes the list of single-digit rankings. The Sony story is simple. Business does not pick up until the global consumer once again feels like he has money to spend on consumer electronics. For long-term investors, buying here below tangible book value looks like a pretty good bet on the eventual global recovery. This stock sells at just 20% of the 2008 highs. A recovery to just half that level over the next five years would give investors a spectacular return on their money.

This was an instructive exercise. Following Carl Jacobi's advice to "invert, always invert" provides some solid insights and good stock ideas when applied to the IBD ranking table.

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