Will These Stocks Win From the January Effect?

What does Conan O'Brien have in common with small-cap stocks during December? Both were punished unfairly. O'Brien, with his awesome red pompadour, worked the late-night circuit for 16 years to get a shot at the big time. In the end, his Tonight Show stint lasted a paltry seven months, as he refused to let execs move his time slot past midnight to make room for Jay Leno.

In the world of investing, the same thing occasionally happens to small-cap stocks around the end of the tax year. In investing guru Peter Lynch's Beating the Street, he described a phenomenon he termed the January Effect. "You could make a nice living buying stocks from the low list in November and December during the tax-selling period, and then holding them through January, when prices always seem to rebound. This January effect ... is especially powerful with smaller companies," Lynch said.

Small-cap losers
With that in mind, I kept my eye open for small-cap stocks with market caps between $250 million and $1 billion that fell at least 15% during the last four weeks of 2010. The list below includes some of those companies.

Company

Market Cap
(in Millions)

Stock Price Change, Last 4 Weeks of '10

Industry

CAMAC Energy (AMEX: CAK  ) 267.1 (35%) oil
Mesabi Trust (NYSE: MSB  ) 528.5 (27%) iron ore
OptionsXpress (Nasdaq: OXPS  ) 845.5 (18%) brokerage
Orion Marine (NYSE: ORN  ) 309.9 (22%) marine construction
Pain Therapeutics (Nasdaq: PTIE  ) 283.8 (15%) pharmaceutical
Sycamore Networks (Nasdaq: SCMR  ) 602.6 (18%) Internet networking

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

Let's dig further to see if these stocks dropped for a good reason, or if they might stand to benefit from the January Effect.

Special dividends
Several of the companies on this list fell for a very good reason: They offered their shareholders large year-end dividends. OptionsXpress, Pain Therapeutics, and Sycamore Networks all paid special dividends amounting to 20% or more of their predividend share price. In theory, the stock price should have fallen by the same amount, which explains the declines.

Additional stock offering
When a company sells additional shares to the public at a discount, it dilutes the value of existing shares. That's what happened with CAMAC Energy, which offered 9.32 million shares in a public offering to raise money to improve a rig off the coast of Nigeria. The shares were sold at $2.20, a huge discount to the stock's pre-offering close of $2.64. After the announcement, the stock's price plunged more than 20% to below the $2.20 offering price. That makes the reason for CAMAC's drop pretty clear.

Lowered outlook
On Dec. 21, Orion Marine management cited production problems with three of its current jobs. As a result, it updated the fourth-quarter outlook, lowering revenue guidance by $15 million and cutting EBITDA margins by two percentage points. The market reacted strongly, slashing the stock's price by 23% the next day.

Who's left?
Mesabi Trust is the only small-cap company from the group that I think may have reasonably suffered from the January Effect ... and could benefit in the days and weeks to come. Mesabi owns the rights to 9,750 contiguous acres in the Mesabi Range of Minnesota, which holds one of the largest deposits of iron ore in the country. The trust's purpose is to distribute its profits -- which fluctuate with the underlying value of the iron ore -- to shareholders through dividends.

This helps explain why dividends can be so choppy from quarter to quarter. In April 2008, shareholders received just $0.12 per share. By October 2008, the payout increased more than 10-fold to $1.25 per share, only to fall more than 90% to $0.11 in January 2009. The most recent quarterly dividend was $0.91, suggesting a forward yield of around 10%.

Clearly, this isn't the company for someone looking for a steady stream of dividend income. It's also not ideal for the faint of heart. If you're a long-term investor, however, there's a lot to like. As a trust, Mesabi has zero debt. Demand for iron is running high again, as China needs it to continue building its infrastructure. Furthermore, Mesabi's rights to the Peters Lease, its largest stake, run out only after all of the ore has been extracted. That's something Great Northern Iron Ore Properties (NYSE: GNI  ) can't claim; in 2015 its land in the Mesabi Range will be turned over to ConocoPhillips, the company dissolved, and the shares retired.

And yet, on Dec. 16, Mesabi shares plunged 16%. Then, just a week later, they plunged again, this time falling 10%. Fellow Fool Brian Pacampara, said it looked "like another opportunity to pounce" on the company's shares.

Given that Mesabi shares had surged fivefold during 2010 before the big drops, profit taking may have seemed like the sensible thing to do. It also is the type of thing that lands Mesabi's shares in the company of Conan O'Brien: things that were unfairly punished. Got any other examples of stocks (or people) unfairly punished? Please share them below!

Fool contributor Brian Stoffel thought about using Shoeless Joe Jackson instead, but thought Conan was a better bet. He does not own shares in any of the companies mentioned. optionsXpress Holdings is a Motley Fool Stock Advisor pick. Try any of our Foolish newsletters today, free for 30 days.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 13, 2011, at 12:44 AM, dumbokie1 wrote:

    I don't know if they were unfairly punished or not, but AMED, AFAM, COCO, and others in the same industries fell significantly during 2010. The medical care giver stocks were accused of over billing medicare. It looked like a blanked indictment or the companies locked together in their overbilling. The online educational stocks were charged with rounding up misfits on the street and offering them a government loan to attend their schools and get a well paying job. They were charged with asking druggies and alcoholics on the street to sign up, knowing they couldn't pay back their loans. It is obvious during the past 18 months most everyone was unable to obtain a job, regardless of their educational achievements. Are any of these targeted companies worthy of some buying action? I bot AMED at $28.15.

  • Report this Comment On January 13, 2011, at 5:20 PM, brewersfan81 wrote:

    dumbokie1-

    Though I think the reasons for these drops would disqualify the companies as "suffering from the Jan effect", I still think an argument could be made that they were unfairly punished. I'm unfamiliar with AMED and AFAM, so that would require some research, but I'm still quite bearish on for-profit schools. STRA's earnings caused a 25% drop. And although APOL has shot up recently, much of it was just gaining back what was lost the previous day because of STRA's results. Also, APOL's beat was primarily attributable to a rise in tuition. Of course, students who are half-way to their degree will probably bite the bullet and pay the increase, but enrollment is still dwindling, and I doubt the tuition increase is going to help attract students. Though I don't have any specifics on COCO, I'm being very cautious within this industry.

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