One sound investing strategy is to buy shares of troubled companies that are trading on the cheap with the goal of selling them at a later date when their fortunes have turned around. However, the key to making this strategy work is to buy companies that are temporarily going through tough times, otherwise, you risk owning a value trap.
With that in mind, we asked a team of investors to share a company that is currently trading on the cheap. Read on to see what they had to say about Carrols Restaurant Group (TAST), GameStop (GME 1.50%), and TEVA Pharmaceuticals (TEVA 1.01%).
Image source: Getty Images.
A burger better for your portfolio
Rich Duprey (Carrols Restaurant Group): The largest franchisee of Burger King restaurants in the U.S. looks like a tasty stock for investors looking for deeply discounted companies. Carrols Restaurant Group operates almost 800 restaurants that are expected to generate over $1 billion in revenues in 2017. While its second-quarter earnings report showed sales jumped 16% as it added 170 new restaurants to the mix, comparable-store sales were also up 4.6% as traffic rose 1.3%.
McDonald's also posted higher traffic in the quarter as diners seem to be returning to the quick-serve format after having dined at fast-casual, better-burger chains for a few years. Now the likes of Shake Shack and The Habit are struggling to get repeat customers.
Still, Burger King's performance has been more consistent than either McDonald's or Wendy's, with the former previously reporting higher traffic early on only to see it turn negative later in the year. McDonald's has posted four straight years of lower customer counts.
Carrols' performance this quarter was driven by demand for its mix of premium and value menu offerings, while limited-time promotions helped pique consumer interest. Profitability, though, took a hit as higher labor costs, rising beef prices, and greater discounting ate away at earnings, causing GAAP per-share profits to fall 38% from last year.
That caused the market to take a bite out of its stock price, which gives investors an opportunity to grab a bite of a solid brand at an absurd price. Despite Wall Street expecting Carrols to grow earnings at a compound rate of 25% annually over the next five years, its price-to-earnings ratio trades at just a fraction of that growth and it goes off for a deep discount on its sales as well. At less than eight times the free cash flow it produces, Carrols is being priced like a burger that's been left under a heat lamp for too long.
The fire sale for GameStop
Demitri Kalogeropoulos (GameStop): With a market capitalization of $2.2 billion, GameStop is valued at just around six times the $353 million it earned last year, compared with a P/E multiple of 24 for the broader market.
Investors have good reason to be pessimistic about the outlook for this business. The retailer's comparable-store sales plunged by 11% in 2016, after all, as a slump in the core video game market was only partially offset by gains in new business lines like consumer tech and collectibles. Add a broader industry challenge that's reducing customer traffic across most physical businesses and GameStop seems like a good stock to avoid.
On the other hand, its finances are strong. In fact, the company generated higher gross profit last year despite the shrinking sales base. It kept its bottom-line profit margin steady at roughly 4%, too. Cash flow is over $500 million a year and easily covers the company's massive 7% dividend yield.
GameStop's latest forecast leaves open the possibility that its sales growth slump will end this fiscal year. CEO Paul Raines and his executive team have projected comps that range from a 5% decline to a flat result as earnings slip to $3.25 per share from $3.40 per share a year ago.
No, those aren't exciting sales and profit figures. But they're also far from the gloom and doom that's reflected in the stock price. Meanwhile, GameStop's rock-bottom valuation gives it room to rise if its business shows even a slight improvement in operating trends.
Everything is going wrong for this generic-drug maker
Brian Feroldi (TEVA Pharmaceuticals): The stock market may be regularly hitting new highs, but investors in TEVA Pharmaceuticalsals haven't benefited from the general prosperity. Shares of this generic drug maker have been on a sickening downward slide for quite some time as they have been cut in half since January alone. The huge sell-off has pulled the company's forward P/E ratio down below five and its price to sales has fallen to its lowest level on record.
What has gone so horribly wrong that justifies such a vicious sell-off and absurdly cheap valuation? Here's a quick review of the company's problems that have caused Wall Street to give up hope.
- The company's U.S. generic business is facing huge pricing and volume pressure, which is affecting profits.
- Sales of specialty drugs are on the wane. What's more, sales of the company's top-selling multiple sclerosis treatment Copaxone fell by double digits last quarter.
- Margins are plunging across the board.
- Adjusted net income is falling and is coming up short of Wall Street's expectations.
- The company was forced to record an impairment charge of more than $6 billion.
- Guidance was cut.
- The company doesn't have a CEO and is having problems finding one.
- The cash balance is down to only $600 million while its total debt exceeds $35 billion.
- The dividend was slashed by 75%.
Given the laundry list of problems, it isn't hard to understand why shares have taken such a beating.
Could brave investors make a fortune by buying at today's fire-sale prices? That is a possible outcome since the company's assets do still have value. Furthermore, bringing a transformative CEO on board and cutting costs across the board could result in meaningful gains for shareholders.
However, I've been investing long enough to know that turnaround stories rarely end well for shareholders. For that reason, I plan to avoid TEVA's stock like the plague and would suggest that you do the same.
