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Long Travel Centers of America/Short Sirius XM Radio
With stocks under $5 the key factor in a market of uncertainty and nervousness about a possible recession is profits. Investors are quite unforgiving when it comes to companies making money vs. companies losing money. There is simply no appetite for dreams no matter how big.
It makes sense that investors would re-evaluate prospects of companies trading under $5 per share at the end of a bull cycle. These companies tend to be on the edge of profitability and require the momentum of positive GDP growth to keep the dollars flowing. If economic activity reverses course profits can evaporate and losses accelerate. Those losses can be substantial hence the unforgiving nature of investors when it comes to a less than $5 stock that appears wobbly.
In searching for a pair trade then, absolute return investors would be wise to focus intently on earnings and future earnings expectations when selecting stocks for a pair trade. My choice for the first pair trade is
Travel Centers of America(TA - Get Report). This recently recapitalized company operates truck stops across the national freeway system. The small-cap stock is one that is solidly in the black with future profit growth expected to be strong.
In the most recent quarter ending June 30, 2011, Travel Centers reported profits that greatly exceeded analyst estimates. The company made $1.01 per share versus the average Wall Street estimate of 77 cents per share. The stock traded higher after the news, but dipped below $4 per share during the last market sell-off. While shares have rebounded to $4.50 per share today, the stock is still inexpensive relative to expected profits and growth.
Investors can buy Travel Centers for just 11 times current year profit estimates that are expected to double in 2012. Buy Travel Centers long in a pair trade. On the short side of this trade I will take
Sirius XM Radio(SIRI - Get Report). The satellite radio company has been fighting hard to make a profit. A recession would severe hurt its prospects as consumers tighten budgets and eliminate discretionary spending on things like satellite radio.
Considering the company has a market capitalization closing in on $7 billion, investors will be greatly disappointed should profits become elusive in a recessionary environment. Sirius is a stock that has plenty of passionate believers. No doubt the potential of its products combined with its virtual monopoly are enticing to investors.
The problem is timing. The window for this company to make its mark is beginning to dwindle. While Satellite dominates terrestrial radio, competition from smart devices and the like will make it difficult for Sirius to reach its full potential. I was a believer in the story at one point, but I am no longer. Sell Sirius short in a pair trade of under $5 stocks with Travel Centers of America.