Broken stock? Or broken company? On down days or meandering sessions after days where the market explodes higher I like to look for merchandise that's damaged even as the underlying company's doing just fine.
Most people do not like to do this.
Most people like to chase what is hot, what's being bid up, hoping to be able to get in on the next big thing, not before it has happened, but while it is happening. I totally get that. Who doesn't want to be riding a red-hot tech stock like when Nvidia (NVDA) was charging ahead almost daily. Who doesn't want to own a cannabis play like GW Pharmaceuticals (GWPH) when it gets the acclaim it deserves or a retailer, like lululemon (LULU) that's on the run?
But if you really want to have much bigger gains than you can get from riding a hot stock, you have to buy the cold stock of a once-hot company that could ignite again.
These kinds of situations happen every single day and I want you to be on the lookout for them as they represent the real opportunities for meaningful returns.
What kinds of gains am I talking about? Let me give you the quintessential example. A month and a half ago, President Trump decided that Amazon (AMZN) was paying too little to the U.S. Post Office for its distribution and he ignited a tweet storm against the company for paying too little to ship its packages.
Put aside the fact that Amazon negotiated a price with the Post Office that, according to the former Postmaster General, was profitable for the Post Office. Forget that some would suggest that the president attacked Amazon because its CEO, Jeff Bezos, owns the Washington Post, which has been critical of the president.
The tweet tsunami just crushed the stock.
Now most of the time Amazon's stock has been on the run. But the president's tweets helped knock it down 200 points, an extremely rare break in a stock of one of the greatest companies of all time.
It was painful to buy. The president hit Amazon multiple times, each time knocking it lower. But had you done any amount of work you would have realized that even if the president was right and the U.S. Post Office had free reign -- or at least enough free reign to rip up the contract and get it repriced at a level that was substantially higher but below where FedEx (FDX) or UPS (UPS) would offer to do it -- Amazon may have had its earnings reduced by a nickel. A nickel!
I remember telling people when I was on vacation that they had to buy the stock, that my charitable trust, which you can follow along by joining the Action Alerts PLUS club, was picking it up every time the president tweeted. Not a soul wanted to take me up on it.
And then what happens? Amazon reports the single best quarter of the year with a dramatic 40% increase in sales growth. It was the perfect example of a broken stock, not a broken company.
Sometimes these gains can be fleeting and you have to act fast. We had Take-Two Interactive Software (TTWO) on Mad Money last night. A week ago it reported and its shed seven points almost immediately because one of its titles was late and another had some weakness.
But if you had just waited a few minutes, on the conference call the company's CEO, Strauss Zelnick, announced a fixed date for Red Dead Redemption 2, an eagerly anticipated release that had been delayed several times. The stock quickly made up the seven points and ultimately tacked on three more. That's how big Red Dead 2 will be. That's how much money it will bring into the company's coffers.
How about something that you can still act on? Last night we had on the CEO of International Flavors & Fragrances (IFF) , long a favorite of mine. Here's a company that recently made a bold move to buy a competitor, Frutarom (FRUTF) , that makes lots of natural tastes, an explosive category that currently IFF doesn't have much of a franchise.
The problem is the deal costs a ton, $7 billion for a $9 billion company and the stock dropped $17 in response, not just because of the big price tag but because IFF will have to do a $2 billion equity offering to help fund the acquisition. That totally freaked people out. In fact, you had an analyst who had just upgraded the stock to a neutral from a sell go right back and downgrade it to a sell from a neutral.
All of this would be terribly painful if you owned it. But what if you didn't? You can now buy it at a price that I bet will be below where the $2 billion deal comes. Of course, there are no assurances on that but, given that this deal is hugely accretive next year why not buy half now and half on the deal just in case I am wrong. That's a classic broken stock, not a broken company.
Or how about Waste Management (WM) ? Here's a company that's doing incredibly well, with tremendous business all over the country that's growing like a weed because of all the construction -- the principal source of waste --that's going on. However, its stock got dinged last time it reported because one line item on its mosaic of businesses got hurt: newspaper recycling, as the Chinese, the major buyers of the stuff, pulled out, no doubt because of the trade war. Now we know that the Chinese absence is in the stock already. But how about if they come back in, certainly logical given how the president is making nice with the PRC? Why not buy it now, before the Chinese come back to buy more recyclable newsprint?
Then consider Raytheon (RTN) . The company makes missiles for countries all over the world, something that President Trump encourages allies to buy. Today it caught a downgrade from a major firm that said all U.S. defense stocks are too expensive and the group is peaking. I don't know about that. It sure isn't the case when it comes to orders. I think the analyst broke the stock, but he didn't even dent the company with the hottest product in the entire universe of armaments.
Or how about Nordstrom (JWN) ? Here's a brick-and-mortar company with an excellent balance sheet that simply executed poorly this last quarter and its stock fell to $45 from $51 in one day. I think it was a highly emotional, super-charged session where panic was everywhere. I would argue that while the company did screw up, it only wrecked the stock, not the business. The managers are good enough to fix the screw-up while you wait and earn a 3.2% yield. In the meantime, it is always possible that the Nordstrom family, which wanted to buy the whole company for $50 not that long ago comes back and bids, now that the stock's almost 10% lower than the potential take-out price.
Now, though let's take the other side of the trade, the broken company that you must avoid. This morning, Marvin Ellison, CEO of J.C. Penney (JCP) , abruptly quit to be the CEO of Lowe's Corp. (LOW) , the big-box hardware chain. He had worked at Home Depot (HD) before going to Penney and his arrival at the venerable chain almost three years ago was immediately heralded as just who the company needed to break out of its spiral down. "The CEO who is reinventing J.C. Penney," Fortune Magazine crowed six months after he arrived. "Marvin Ellison has scored some early successes but there is a lot left to fix."
Now do we buy the stock of J.C. Penney down at two and change? I submit the answer is no because I think it's a broken company. What makes me say that? Because I looked at where the company's bonds were trading as bond buyers tend to be a lot more discerning that stock jocks. Its 5.875% secured notes due 2023, got hammered today and now yield 7.6%. and its unsecured notes, the 8.625s due March of 2025, now yield an astoundingly high 11%. Those are total red-flags, suggesting that the company's actual survival might be at stake.
Remember, we are looking for the stocks of very good companies that might have made a misstep or got downgraded -- and not for good reasons -- or are mispriced because of emotional, panic-selling. We don't want the stocks of companies in peril. As long as you know the difference, I bet you make a lot more buying a distressed stock of a solid company than a stock of a company that's depressed for a very good reason, the enterprise itself may be in jeopardy.