In 2012, Hewlett Packard Co. was on the brink of vanishing, it seemed.Jim Young/Reuters
Back in 2012, Hewlett Packard Co. was one of the most unloved stocks in North America. Its share price had plunged by about 75 per cent in less than two years. Apple Inc.’s iPad was cutting into its personal computer sales, profit margins were falling in all of its major businesses,and two CEOs had been shown the door.
The company’s niche in the fast-changing technology world was uncertain – it seemed at risk of vanishing, like Eastman Kodak Co. or Atari Corp. It was a stock that few investors wanted to buy.
Lorne Steinberg, president and portfolio manager at Toronto-based Lorne Steinberg Wealth Management Inc., didn’t see it that way. When he looked at HP, he determined that its printer business was worth more than its entire share price at that time, and the breakup value of the company was $40 a share, about triple the share price at the time.
“After we bought the shares at $13, it fell by another 20 per cent, but we never wavered in our conviction,” says Mr. Steinberg.
In 2014, HP announced plans to split itself into two separate firms, one focusing on printers and computers and the other on business software. The move helped the company refocus and kick-started its shares. By the end of the year, its stock price had tripled from its low in 2012.
“We had bought a stock with no ‘buy’ recommendations from Wall Street analysts – a very unloved stock,” says Mr. Steinberg. “However, when a stock is out of favour, any piece of positive news is often enough to move the share price higher.”
The HP case is an example of the power of investing in unloved stocks. It’s a strategy with many variations, but at its core is the philosophy of all value investing – buying shares of good companies at a reasonable price.
Investing in unloved stocks takes it one step further: buying companies that are mistakenly seen as bad, at a significant discount to their historical share price.
“If you invest in stocks that are ‘loved,’ that usually means those stocks have moved up substantially and they are probably relatively fully priced,” says Mr. Steinberg. “When you buy an ‘unloved’ stock, you are buying it after the price has fallen, and therefore the risk/reward is much more attractive.”
Most “deep value” investors will use this strategy to some extent. They may shop for unloved stocks on an individual basis or as part of a more systematic approach.
Some techniques can be considered systematic approaches to buying unloved stocks.
One well-known example is the “Dogs of the Dow” strategy. It involves buying stocks among the 30 companies in the Dow Jones Industrial Average that have the highest dividend yield or the ratio of a company’s annual dividend compared with its share price. The selected companies tend to be those whose stock prices have fallen the most. They are usually quality companies that have become unloved, usually due to short-term challenges. The strategy has proven to beat the market in most years.
In a Canadian variation of the “Dogs of the Dow,” the investor begins the year by buying the most unloved bank stock of the previous year – the one whose stock price was the weakest performer. The rationale is similar: You are buying an excellent business at a discounted price to its peers. This strategy has an even more consistent track record than the “Dogs of the Dow,” but without a catchy name.
One risk of buying unloved stocks is investing in a troubled company whose fortunes continue to decline, taking its share price down as well.
“Prices always fall for a reason, and it is the job of the analyst to determine whether the price drop is due to temporary issues or whether there is a more serious issue,” says Mr. Steinberg.
A related risk is being caught in “value traps.” That is, unloved stocks that will stay that way, despite their apparent value. The key to avoiding them, Mr. Steinberg says, is to determine the reasons the share price has fallen.
The stock of BlackBerry Ltd., then known as Research in Motion, started falling as competitors gained market share.Ryan Remiorz/The Canadian Press
He points to BlackBerry Ltd. as an example. Back when it was still known as Research in Motion, its stock price started falling as competitors gained market share, and its valuation may have looked cheap based on its share price history. But the environment had changed due to competitive pressures, and earnings went into long-term decline.
Mr. Steinberg notes that it’s time to sell your unloved stock when the fundamentals of the business erode, not just because the share price remains stagnant. “Nothing stays cheap forever, and nothing stays expensive forever.”
There is no doubt the most unloved sector of the market right now is oil and gas. Over the past four years, the S&P/TSX Capped Energy Index has lost more than half its value, with many prominent names declining by even more.
But some analysts see opportunity.
Is the oil and gas sector finally on its way back?Charlie Riedel/The Associated Press
Josef Schachter, president of Schachter Energy Research Services in Calgary, says sentiment in the sector hit a low late last year, with indiscriminate selling for tax purposes.
“People were just throwing out stocks in tax-loss selling season,” says the long-time market analyst.
Mr. Schachter now sees positive factors for the sector, including a rebound in the price of crude. He says Canadian energy stocks have recently traded at the lowest valuations he’s seen in his 40 years in the business.
Of course, it’s important to do your homework. Mr. Schachter recommends looking at a company’s balance sheet, the historic highs and lows of its stock price, and how much it will be able to benefit as energy prices recover.
“When sentiment is most negative, and companies become real bargains, is the time to take advantage,” Mr. Schachter says. “People understand commodity cycles and how much money can be made at the top. Commodity investors know these stocks quickly go from hated to loved.”