5 Beaten-Down Stocks Actually Worth Buying

One man's trash, they say, is another man's treasure. For investors that are willing to hold their noses and go Dumpster diving, this can certainly be true in the stock market.

Those who have tuned in for a few of my columns know that my usual modus operandi is to find high-quality companies that show love for their investors through dividends. And while strong dividend payers do make up most of my portfolio, my holdings aren't quite that one-dimensional.

In fact, a portion of my portfolio is stocked with companies that have hit some serious bumps in the road and as a result have simply gotten so cheap that I couldn't pass them up. And while the market's double-digit run since mid-summer has made it a little tougher to find super-cheap stocks, there are still some lurking out there.

Rule No. 1
Though I don't follow his model exactly, the inspiration for this corner of my portfolio is Ben Graham's deep value approach. Graham would seek out the absolute most down-trodden stocks and put together a portfolio based on these "cigar butts" that still had one puff left in them.

A key piece of Graham's strategy though was that he wasn't keying in on one or two individual stocks. Instead, he would find a whole host of left-for-dead stocks and create a portfolio with a bunch of them. So rule No. 1 when taking this approach is: Don't put all of your eggs in one basket.

5 to consider
What initially puts a company on my Dumpster-diving radar is a low valuation. I typically screen for companies that are selling at less than half of their tangible book value. Once I have that list, I use some softer criteria to further dig in and figure out which companies will be the best bets. I look for companies that have at least a decent underlying business that's been able to produce profits in the past; if it's currently in the red, I want to feel comfortable that losses won't swallow up the rest of the equity value; and I prefer to see a company that is still churning out cash even if it's not showing accounting profits.

With those guidelines in mind, here are five Dumpster stocks that I think are worth putting on your radar:

Company

Price / Tangible Book Value

Previous 12 Months Net Income (loss)

Previous 12 Months Cash Flow From Operations

Genworth Financial (NYSE: GNW  ) 0.4 $343 million $1.1 billion
Marshall & Ilsley (NYSE: MI  ) 0.4 ($642 million) $846 million
Mirant (NYSE: MIR  ) 0.3 $294 million $434 million
Excel Maritime (NYSE: EXM  ) 0.3 $276 million $169 million
Presidential Life (Nasdaq: PLFE  ) 0.4 $17 million $23 million

Source: Capital IQ, a division of Standard & Poor's.

While those numbers tell part of the story, let's take a bit of a closer look to see why I think the market is misjudging these stocks.

Genworth has been tangled up in losses incurred as part of its mortgage insurance business -- which, if you haven't heard, hasn't been a great business to be in lately. The company is, however, much more diversified than mortgage insurance competitors like Radian (NYSE: RDN  ) and MGIC Investment, and that's shown up as much more contained losses at Genworth. I think the discount that investors have put on Genworth's stock assumes losses far larger than the company will face.

If you believe the numbers, then the banking sector is slowly, but surely, starting to recover. But while investors are starting to get comfortable with some banks again, others, like Marshall & Ilsley, continue to be on most investors' "avoid" list. Thanks to heavy exposure to hard-hit areas like Arizona, M&I's loan book still looks pretty sickly, and Moody's has continued concerns about the bank's financial strength. However, I think the current valuation shows that investors are expecting loss levels that will be well above what M&I will actually end up facing.

Mirant will no doubt keep investors on their toes. This electric power generator's results tend to swing pretty wildly thanks to its hedging activities, new environmental regulations could impose new costs, and the company is preparing to merge with RRI Energy (NYSE: RRI  ) . While investors seem to be attributing very little value to Mirant's assets, I see them as a good backstop for the stock, while some nice upside could be in store if today's pessimism proves overdone.

Dry-bulk shipping is a cyclical business, and when the arrow is pointing in the wrong direction, investors start to jump ship. Overcapacity has started to weigh on shipping rates even though the steel market -- which drives demand for iron -- has been stronger recently. On the basis of low valuation, investors pretty much have their pick of dry-bulk carriers, but I went with Excel because it's among the cheapest and has a better-than-average balance sheet.

Finally, Presidential Life is ... well, it appears to simply be overlooked. Granted, the provider of annuities and life insurance has never been a destination for excitement, and the recession battered its investment portfolio. The company is still no thriller today, but it appears to be on the mend. Besides the stock's low valuation, investors get the added benefit of a 2.7% dividend while they wait around.

I'll be adding all five of these stocks to my CAPS portfolio, and after my trading lock-up expires, I may be adding one or more of these to my personal portfolio. Think I'm crazy to be even considering these stocks? Head down to the comments section and share your thoughts.

Want quality over cheap? In this free report, my fellow Fools serve up five stocks that The Motley Fool owns and they think you should own, too.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (18) | Recommend This Article (47)

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  • Report this Comment On December 03, 2010, at 10:23 AM, grseidel wrote:

    I am thinking the reason M&I is beaten down is that some are afraid that they will have raise more capital thereby diluting shares further....I like M&I and I am watching it closely, very closely.....

  • Report this Comment On December 03, 2010, at 7:30 PM, TMFKopp wrote:

    @grseidel

    "I am thinking the reason M&I is beaten down is that some are afraid that they will have raise more capital thereby diluting shares further"

    Yup, that's a primary concern. But the question is: What are market expectations versus likely reality? My take is that today's valuation suggests a much bleaker reality than is likely.

    Matt

  • Report this Comment On December 03, 2010, at 7:50 PM, TMFKopp wrote:

    @GermanInvestors

    Your comment is a bit confusing. When it comes to the smaller companies that I've highlighted here, you say:

    "The market never lies!"

    Which suggests that you're talking about some version of efficient markets. But then you go on to say that there are cheap large caps out there.

    Which is it? Does the market never lie and low valuations are simply a reflection of real risks? Or can there be truly cheap stocks that the market has mispriced?

    Being Foolish myself, I subscribe to the latter. As for large caps versus small caps, I do actually tend to agree with you that there are cheap large caps out there right now. However, if you want to talk market efficiency based on company size, you're generally going to find less efficiency among smaller companies because there simply are fewer investors following them.

    So circling back to your "market never lies" comment. Actually, I think the market does lie sometimes. More often the market is just lazy, ignorant, or downright stupid.

    Of course it appears to me that your comment doesn't really have much of a purpose other than to allow you to link back to your blog. And to be frank, based on your blog post (and your comment) it doesn't appear that you have much of an understanding of what you're looking at.

    For instance, you cite average growth among the group of large caps as 316%, which is clearly ridiculous. Taking a look through the list you posted to the blog, you've got numbers in there that are just nonsensical -- like NTT growing more than 11,000% next year. Not only would that normally be an outlier in an average, but the number appears to simply be wrong.

    What may be more useful to your readers is rather than just blindly pulling down lists from screens, pick out a few stocks that actually look interesting to you and talk a little bit about why they're cheap and what's driving the growth in the year ahead.

    Matt

  • Report this Comment On December 04, 2010, at 12:39 AM, mizzar wrote:

    This happened to AAPL in 2008. It happened to XOM early this summer. It also happened to VECO in August of this year.

    I'm surprised CSCO isn't on your list, since it happened to them a few weeks ago and the stock is still ripe for the picking.

    In fact, I'd bet traders will leave the realized loss on their taxes this year and scoop up CSCO for dirt cheap on January 2nd.

  • Report this Comment On December 04, 2010, at 6:28 AM, rmrrikz wrote:

    Wish to learn more....

  • Report this Comment On December 04, 2010, at 11:12 AM, investchief wrote:

    I like this article and its trades. I would argue that Cisco is another beaten-down stock that is worth buying. yes, the quarterly earnings were a disappointment but i think they have this in the long run and we can pick up some cheap shares.

    check out my investment blog for more details and trades: http://investchief.blogspot.com/

  • Report this Comment On December 04, 2010, at 11:33 AM, BruceCortez wrote:

    I do quick checks to see if a stock is worth continued research, and time. The starting check is always Return on Investment Capital (ROIC), or for financials I use Return On Equity (ROE). I need to see a 10% growth rate as a minimum for 1 year, and 5 year numbers to continue.

    (MI 5.60) is near its 52 week low, but the ROE numbers are at a negative growth rate. for this reason I would stay away from this one.

    (PLFE 9.82) is also near its 52 week low, but the ROE is better at 2.6% for 1 year, and the 5 year is at 7.7%, below my limit of 10%.

    (MIR 10.39) ROIC numbers are very much below 10% at 3.9% and 6.3%, Not acceptable.

    (EXM 5.85) ROIC is at 9.5% for the most recent year, and 7.6% for the previous five years.

    ROIC, and ROE do not guarantee the stock will increase in value, but I like assurance that my principal will not be lost because a company has filed bankruptcy.

    Good ROIC, and ROE tells me that the stock is worth continued research, and even then the stock may not be acceptable as the research continues.

    With so many companies (stocks) available, the investor is able to pick the best for investing.

  • Report this Comment On December 04, 2010, at 12:13 PM, PaulEngr wrote:

    I similarly checked the posted list of large caps. All of the ones that claim a return in excess of 100% over a one year period look HIGHLY unlikely to achieve this, indicating that wherever the growth rate estimate comes from, it is 100% bogus.

    TM is going to increase 300% in one year? Are you kidding me? They have a huge, HUGE long term image problem. TM built themselves up an image of being better than anyone else, and because they also had a HUGE honesty issue (so blatant that their Consumer Reports rating was utter crap and Consumer Reports finally came out and admitted it). So now they've got to do massive image repair before they can expect customers (and investors) to return again. All the while competing with the likes of the new Government Motors and Ford. The numbers on that list aren't even close to passing the smell test unless you're a Wall Street analyst.

    Capital One? Wow, since when did the credit card business (and those not defaulting on their cards) get so good? Again, smell test fails here.

    As to the recommendations...

    I fail to see how anyone with a lick of sense could invest in a financial company of any sort. Have the last 5 years proven nothing other than the fact that their SEC filings are a patent farce since they can make up any numbers they want? I have two rules that I follow: never bet on government, and never trust a bank. I violated both of them in the not too distant past by betting on a little known financial called Fannie Mae when they took the first dip as the housing market came apart figuring that I was safe because it's a quasi-government entity in spite of being a financial...and the rest is history. About all I learned from this experience is that my two rules were completely vindicated, and seared in my brain forever. The rest are no better, government backing or no. In case you haven't noticed the news lately, what Congress can't do directly the Fed has been doing indirectly, even propping up GE Capital, another business entity worth flushing before the economy is going to truly recover.

    That leaves Mirant and Excel. In terms of Excel, look...Europe is basically a situation of waiting for the other shoe to drop, and they are twice the influence on this country that the BRIC's are. Although domestically there are signs of at least some stability, the U.S. is nowhere close to out of the water especially when it comes to exports (or imports for that matter considering the Chinese stability issue).

    As to Mirant...ok, here's one potential needle in a haystack. But why bother investing in a power company when you can simply invest more directly in energy stocks and avoid the whole hedging fiasco? CHK is right now trading roughly around their usual cyclical low again. Just have to get over their rather flamboyant management group.

  • Report this Comment On December 04, 2010, at 5:41 PM, TMFKopp wrote:

    @mizzar and investchief

    I was looking for stocks trading at a fraction of the company's tangible book value. Cisco is trading at a very significant premium to its tangible book value. That doesn't mean that Cisco may not be a good value right now, but it's not nearly cheap enough (based on that particular metric) to make this list.

    Matt

  • Report this Comment On December 04, 2010, at 5:52 PM, TMFKopp wrote:

    @BruceCortez

    It's that kind of rigid focus on certain numbers / ratios that allows some stocks to get very cheap. When investors don't bother to do any further research on a stock / company because a certain ratio doesn't meet their set criteria, that opens the door for there to be situations where something is going on that makes the stock attractive despite the unattractive ratio.

    One interesting thing to think about is when you've got a company that's returning 6% on its equity. Not very attractive. But what if new investors can buy in and pay only half the equity value?

    Now that all said, for the core of my portfolio I do take an approach more similar to what you're talking about -- that is, looking for the best companies and ones that produce attractive returns year after year.

    What we're talking about here is a very different situation -- that is, investing in a basket of very beaten down stocks, all of which look like they've been knocked down too far.

    Matt

  • Report this Comment On December 04, 2010, at 6:04 PM, TMFKopp wrote:

    @PaulEngr

    "I fail to see how anyone with a lick of sense could invest in a financial company of any sort. "

    You're far from alone in that view of banks and financials and it's exactly what makes me interested. When a large swath of investors becomes completely unwilling to even consider investing in a certain segment of the market, there's suddenly a much-increased chance that you'll have inefficiencies (and specifically mispricing) in that segment.

    To be fair, I do share a similar skepticism of the banking industry and so it's unlikely that I'd take a big bite on any one bank. However, the idea of betting on a few in a basket (which Alex Dumortier suggested doing with big banks -- http://www.fool.com/investing/general/2010/11/24/the-cheapes... is very interesting to me.

    As to Fannie Mae and Freddie Mac, I hope you don't really think that their situation is really comparable to that of most banks. Sure, many banks are still struggling, but the festering gangrene that's been eating away at those misguided institutions is much worse than anything the banks are facing.

    Matt

  • Report this Comment On December 06, 2010, at 8:06 AM, KWT8011 wrote:

    nice timing on MI, up 20% since you posted on CAPS.

  • Report this Comment On December 06, 2010, at 1:14 PM, kahunacfa wrote:

    Marshall & Ilsley(MI) is a high-quality Milwaukee based conservative consumer and small business bank. The shares should sell in the range of 0.80 to 1.20 times book-value per share. With the stock currently valued at only forty percent of Tangible book vasalue per share, these high quality shares are worth at least twice the current market valuation. Buy several thousand shares while the bank is on sale, sell one-half of the position after the first double to recover the full cost of the position and let the rest of the shares reside in the IRA portfolio for at least the next decade or so....

    Kahuna, CFA

    le 06 decembre 2010

    Kailua-Kona, Hawaii

    Disclosure: KCFA has a beneficial interest in these high-quality shares, as well as a banking relationship.

  • Report this Comment On December 06, 2010, at 1:29 PM, TMFKopp wrote:

    @KWT8011

    Ugh, actually I'm considering it terrible timing because I wanted to buy the stock for my personal portfolio and don't really appreciate the quick run-up! :)

    Matt

  • Report this Comment On December 06, 2010, at 9:27 PM, imacg5 wrote:

    No, all your info on EXM is smoke and mirrors.

    Read this carefully:

    http://www.sec.gov/Archives/edgar/data/842294/00013178611000...

    You have to remove all the "Amortization of below market charters", it's not revenue, and it's certainly not earnings. It's not an accident that the market values EXM at these prices. The market is aware of the farce that is the EXM earnings report.

    And, the balance sheet is way off. The Fleet is valued at the Cost minus depreciation. It is not at all a reflection of the tangible book value.

    On the balance sheet, they value their ships at $ 2.6 billion. They own 41 ships, they list 7 other ships as being under their control, they are leased, not owned.

    That would give their ships an average value of $64 million.

    Not a chance, a new Cape would cost them less than that.

    This is their fleet: http://www.excelmaritime.com/fleet.php

    This is how you find out what they are really worth:

    http://www.cotzias.gr/index1.html

  • Report this Comment On December 12, 2010, at 3:38 AM, underdone wrote:

    Interesting article. Perhaps more so because I own 3 of the companies mentioned.

    In respect of the comments viewed so far

    1) The non cash adjustments to sales income for EXM refer to adjustments made at the time of aquisition of the vessels to reflect the market rate at that time. The other side of the adjustment is to increase or decrease the value of the vessel. Two points need to be covered to understand this (a) depreciation is also charged to the accounts as a non cash adjustment so reversing one non cash adjustment without reversing the other is nonsense. (b) This is the same principle used in valuing bonds and I think the bond buyers and sellers probably know that it is appropriate. The talking heads that adjust one non cash entry and not the other are probably infuenced by something else in adopting their inappropriate behaviour.

    In respect of the book value of their vessels I compared the valuations on a cost (of BV) per tonne. EXM is one of the better values per tonne and was only notably exceeded by a shipping company that uses larger vessels which cost less per tonne. But in respect of larger vessels you still need to find full loads in order to convert that lower cost base into profitability. EXM's BV per tonne compares appropriately to recent sales of similar sized vessels.

    The oversupply issue is also reducing as a result of freight rates being at mid 90's levels resulting in the cancellation or deferral of newer more expensive vessels while older vessels continue to be scrapped.

    2) MIR now GEN forward purchases natural gas to produce power which it forward sells. It does not mark to market it's forward sales of power but is required to mark to market it's forward purchases of natural gas. This distorts it's financial statements temporarily when natural gas prices change resulting in higher profits when gas prices rise and lower profits when gas prices fall. Over time though it's profits are determined by the volume of power sold. The combination of MIR and RRI is expected to add approx 20 cents per share to combined earnings by 2012.

    3) All financials seem to have been tarred and feathered by the financial crisis. Personally I think the best value can be found in insurance companies rather than banks and not merely Surety (mortgage insurance) or Life but also Property and Casualty. For many insurance companies the losses sustained by the fall in value of their investments in 2008 / 09 have already been reversed but in some cases their earnings and certainly their market prices have not.

    4) When comparing ROE's you also need to adjust for book value to arrive at comparable figures. ie a ROE of 30 for a stock with a P/bk of 3 is the same as a ROE of 5 and a p/bk of .5. Both provide a return on investment of 10%.

  • Report this Comment On December 12, 2010, at 3:52 AM, underdone wrote:

    P.S. GNW and now GEN are both large caps when looking at their shareholder funds.

    All other things being equal GEN should generate circa $1.30 per share in 2012 which gives it a forward p/e of 2.75 based on a price of $3.58. Uncertainties include the cost of upgrading its plant to reduce CO2 emmissions however if gas prices remain low GEN will undoubtably be very competitive with other power suppliers using alternative energy sources.

  • Report this Comment On December 29, 2010, at 10:41 AM, oakpkdude1 wrote:

    PLFE has been a dog ever since the former CEO and chairman has left the company. They should hire him back as a consultant. That alone would boost the stock.

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