5 Stocks That Are Sitting on a Market-Thrashing Opportunity

The opportunity I'm about to describe is one that is 100% in Goldman Sachs' (NYSE: GS  ) wheelhouse. Yet the Wall Street bully botched it.

Meanwhile, the five companies I've found have a chance to beat Goldman, beat the market, and make a ton of money for their shareholders.

Let me explain
Goldman Sachs' Ivy-League-trained employees make their living mastering the markets. They help companies do IPOs, raise debt, and buy other companies. They make markets and execute trades for clients. And (though regulation has now hampered this somewhat) they trade in the markets themselves.

And they're damn good at the trading.

How good?

In the first quarter of this year, Goldman's trading desk was profitable 63 days out of 63. Imagine doing that in your own brokerage account!

These weren't just small gains, either. On 35 of those days, Goldman made more than $100 million. Each day.

But they didn't make money on this trade
Take a look at Goldman Sachs' stock price chart over the past few years.

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


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

Even a novice investor sees where Goldman should have bought into its own stock -- the crater in the fourth quarter of 2008 and the first quarter of 2009.

What actually happened was that Goldman Sachs loaded up on its own stock at the worst time. At the height of the good-times housing bubble, it bought back a net $5 billion in 2006. In 2007, it accelerated its repurchases to $8 billion. Then, when the bubble burst and its stock price hit lows, it sold almost $20 billion of common and preferred stock in the fourth quarter of 2008 -- and subsequently sat on its hands in the first quarter of 2009.

Now, to be fair, Goldman hit the worst financial crisis in most of our lifetimes (knock on wood). And it needed to raise that capital-- both via the government and privately -- or face the fate of Bear Stearns and Lehman Brothers.

That said, Goldman makes much of its money from the art of the trade -- and it bought high and sold low. On its own stock!

I don't tell you this to bash Goldman
No, I'm using this example to show how hard it is for any company to time its share buybacks. This high degree of difficulty is one of the reasons many investors prefer dividends to stock repurchases.

It's why many see American Capital Agency's (Nasdaq: AGNC  ) 20% dividend yield and buy in. As a REIT, American Capital Agency has to pay out 90% of its profits, so its management isn't tempted to repurchase mass quantities of stock at inopportune times.

Don't get too excited, though. The irony of the REITs is that because they have to pay out their profits, they have little money saved up for tough times. They end up in danger of doing exactly what Goldman had to do -- issue shares at the worst possible times.

Now I'm usually a big, big fan of large, sustainable dividends, but if a company could make repurchases at periods when its stock price is low, it would be even better than dividends. It creates shareholder value without creating a tax event.

And this is just the opportunity those five companies I mentioned earlier have got on their hands.

The opportunity
To take advantage of share buybacks, a company needs plentiful cash. It also needs a cheap share price.

I went on the lookout for candidate companies by trolling the five-year-low list for companies that have a ton of net cash (i.e. cash less any debt). Here are the five companies I came up with.

Company

Recent Share Price

Change From 5-Year Low

% Net Cash/Market Cap

Electronic Arts (Nasdaq: ERTS  )

$15.62

11.1%

33.5%

Net 1 UEPS Technologies (Nasdaq: UEPS  )

$12.06

46.9%

27.3%

FormFactor (Nasdaq: FORM  )

$8.92

29.5%

88.7%

Shanda Games (Nasdaq: GAME  )

$6.61

32.5%

23.6%

Energy Recovery (Nasdaq: ERII  )

$3.78

22.7%

25.9%

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

Now, I'm not saying each of these companies should definitely pounce on share buybacks. They have to answer "Yes" to two questions first:

  • Is its stock actually undervalued (not just near a 5-year low)?
  • Can the company spare some of the cash (or does it need it for financial flexibility)?

As investors, we hope these companies make the correct call. But we can also take action on our own. Remember, these are companies trading near five-year lows with their share prices buoyed by cash in the bank.

I took the plunge on FormFactor a few months ago despite the company bleeding cash. I'm betting on a turnaround after a recent management shakeup. It's certainly possible the company continues to flounder -- the semiconductor testing equipment space is a tough one. But fortunately, management has a lot of room for error. The stock trades for $8.92 a share. That price is supported by $7.91 a share in cash!

All five companies are worth a second look for similar reasons. But if they're not for you, click here for our seven-page free report: 5 Stocks The Motley Fool Owns -- And You Should Too.

Anand Chokkavelu owns shares of FormFactor. Net 1 UEPS Technologies is a Motley Fool Rule Breakers and a Motley Fool Global Gains pick. Electronic Arts is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a bull call spread position on FormFactor, which is a Motley Fool Hidden Gems recommendation. The Fool owns shares of FormFactor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (51)

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 October 26, 2010, at 5:19 PM, TMFTypeoh wrote:

    Anand,

    Great article, but i think you got this part backwards...

    "That said, Goldman makes much of its money from the art of the trade -- and it bought low and sold high. On its own stock!"

    I think you meant "bought high and sold low".

    Semantics, but nice article.

  • Report this Comment On October 26, 2010, at 6:16 PM, raffoolish wrote:

    Hi!

    I just checked FORM's quarterly financial report.

    C = Cash equivalents 118,554,000 $

    L = Total LIabilities 71,735,000

    S = Shares 50,431,000

    So (C-L) / S = ONLY 0.93 $/share .

    Even C / S = ONLY 2.35 $/share

    Could you please explain where the 7,91$ cash per share come form?

  • Report this Comment On October 26, 2010, at 9:49 PM, 11x wrote:

    I question whether an individual investor can duplicate GS's trading success. I highly doubt they are buying stocks based on fundamental or technical analysis and cranking out the money like mad. I'm sure it involves arbitrage, some form of front running, or market making.

  • Report this Comment On October 26, 2010, at 11:51 PM, TMFBomb wrote:

    @typeoh,

    Guh...yes, I meant the opposite. Clearly. It will be changed soon. Thanks for the catch!

    @raffoolish,

    I used cash plus short-term investments (which is frequently lumped with cash and called simply "cash"...I should have been clearer). As for liabilities, only debt is subtracted to get net cash.

    You can see Yahoo! Finance's number for cash per share in this link (it agrees with my calc):

    http://finance.yahoo.com/q/ks?s=FORM+Key+Statistics

    Fool on,

    Anand

  • Report this Comment On October 27, 2010, at 8:26 AM, devoish wrote:

    Even a novice investor sees where Goldman should have bought into its own stock -- the crater in the fourth quarter of 2008 and the first quarter of 2009.

    What actually happened was that Goldman Sachs loaded up on its own stock at the worst time. At the height of the good-times housing bubble, it bought back a net $5 billion in 2006. In 2007, it accelerated its repurchases to $8 billion. Then, when the bubble burst and its stock price hit lows, it sold almost $20 billion of common and preferred stock in the fourth quarter of 2008 -- and subsequently sat on its hands in the first quarter of 2009.

    And yet those very same managers - trusted to run the company to the benefit of shareholders and many now trusted to run America to the benefit of Americans - managed to sell $680 million of their personal holdings between March 2006 and July 2008 at prices above $150/share, and are sellers again, $250million since October 2009 until present.

    With their personal holdings, in that stock price valley from Oct 2008 until March 2009, GS managers managed to sell only $10 million of their personal holdings. In fact it was in that valley that one insider made the only insider purchase of GS shares in the last five years.

    It is almost like they used their control of the company to manipulate share prices for personal gain at the expense of outside investors.

    The purpose of that last comment was strictly to open eyes and encourage some thoroughly deserved bashing of GS.

  • Report this Comment On October 27, 2010, at 10:22 AM, TMFBomb wrote:

    Huh, looks like FormFactor agrees on stock repurchase:

    http://blogs.barrons.com/techtraderdaily/2010/10/26/formfact...

    -Anand

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