Hungry Dogs:
These stocks tend to operate in the no men’s land. They are not dead enough to file for bankruptcy, but are not healthy enough to do anything but survive. More likely than not they have significant business problems associated with their business. They are surviving, but barely so. Think of them as street dogs running around looking for food.
They either can’t or do not have enough capital to fix whatever problems they have. They are simply getting by and there is no catalyst on the horizon that would indicate that their luck is about to change. Typically they sell at a significant discount to their Intrinsic Value (or perceived IV). To the tune of 50-80%.
As an example, think of an apparel retailer who has been struggling over the last 5 years. Their brand name has been diminished, their sales are down 4-5% quarter after quarter, there is no new store growth, their management is not changing direction, they are sustaining operating losses, there are no interested parties in buying them out, their financial position is very weak and they barely have enough cash flow to keep their operation going.
The bottom line is, avoid these stocks if there is no clear catalyst that could increase their value in the near future. What kind of a catalyst? As per example above it could be a buyout or a takeover, management change, improvement in merchandise, gradual/consistent improvement in same store sales, new store openings, etc…..
If no clear catalyst is present, these stocks are likely to remain in their trading range or worse, shift into the Dead Man Walking category. As such, you don’t want to tie up your capital in such stocks even if the margin of safety is over 50% and your valuation work suggest otherwise. Simply put, these stocks are not going anywhere.
Sleeping Beauty:
Just like a sleeping beauty these stocks are nice to look at, but most of the time they are worthless. Such stocks might look very good in your overall portfolio, but what is the use if they do not contribute to your capital gains. They are certainly better than Hungry Dogs, but not by much.
They are easily identifiable through the following characteristics. The company is growing at a slow rate of about 1-5% per annum. It is financially stable, operating at a profit or a small loss, has enough cash flow to sustain operations for a long time and in no imminent danger from outside factors. Furthermore, the company is making certain changes that seem to be working, but they are not drastic. The company is selling at a significant discount to its Intrinsic Value (20-70%), but its stock price hasn’t gone anywhere over the last 5 years. Plus, there is no clear catalyst to release the value in the near future.
As an example, such a company might include an agricultural company with a lot of land holdings or a REIT that has a lot of assets, a strong financial position, but no real catalyst for releasing that value to the shareholders. Their stock prices end up stagnating, sometimes for decades even though investing in them looks good on paper.
In summary, you want to avoid these stocks as well. They might look good, but all they will do is tie up your capital for a long time without any sort of a real return. Meanwhile you might be losing on other great investment opportunities. The opportunity cost is real and you should definitely take that into consideration when looking at sleeping beauties.
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