One of my favorite hunting grounds for stocks with large long-term potential is among issues that were once Wall Street darlings or solid blue-chip franchises that have fallen into disfavor. The "fallen angel" stocks have been a source of great stock picks, as well as options trades over the years. As long as the fundamentals of the company are not pointing towards imminent demise, they can be great candidates for combo trades buying the stock and selling long-term puts and calls. With risk-free rates basically at zero and volatility stuck in a range, options-selling is not that attractive now, so today I will focus on fallen angel stocks of interest.
To find fallen angels I run a very simple screen. I look for stocks that are in the S&P 500 and have seen their share price fall below $10. These single-digit midgets are companies that have fallen out of favor with investors and are largely ignored. Many institutions have mandates that prohibit owning single-digit stocks and most brokerage firms are reluctant to recommend them. Some of them are heading to oblivion but others have the potential to right the ship and regain favor over time. As the poet Horace once said, "If matters go badly now, they will not always be so."
Of course, the great poet may have a hard time selling that idea to shareholders of companies like Sprint (S) and Boston Scientific (BSX). These companies have suffered from a wide array of difficulties and missteps over the past two years. Every attempt to rally has been hit with a new disappointment and fresh selling. For long-term, slightly more aggressive investors, both are long shots.
My two favorite larger regional banks are on the list. KeyCorp (KEY) and Huntington Bancshares (HBAN) have not been among my most wildly successful stock picks over the past two years but I remain very excited about their future prospects. Both are seeing improvements in their loan portfolios and both are over-reserved against losses. Managements at both banks have done a tremendous job of navigating the credit crisis and economic slowdown and they are positioned to grow at a solid pace when the economy improves. With the shares trading at 70% of tangible book value, KEY is the cheaper of the two stocks, and if you don't own it you should be a buyer. Huntington trades at a slight premium to tangible book, so I might wait for a selloff to start a position in the stock.
Tenet Healthcare (THC) is another one of those companies that just cannot seem to stay out of the penalty box. The second-largest for-profit hospital operator has struggled with falling reimbursement rates and the long shadow of healthcare reform. There are signs of a turnaround for the somewhat downtrodden company, as its Conifer divisions have a large contract with Catholic Health Initiatives to provide business services for 56 of CHI's hospitals. Tenet also recently received $77 million under a settlement agreement with Medicare. Given the level of government control and insurance company payment schedules hospitals, will never be a great business, but that appears to be baked into Tenet's stock price. This is another solid buy-in-decline long-shot stock for patient investors.
Fallen angel stocks can be fertile sources for long-term investors. I usually find a mix of quality, safe and cheap companies, as well as a few worthwhile long-shot stocks for more aggressive investors with a long horizon. Some of the single-digits stocks are dead money, so be sure to do the homework. I will continue to explore option-trading opportunities in this ignored market segment as well, and bring them to Real Money readers as they develop.