One of the marvelous things about Wall Street, particularly as one year gives way to another, is that gravitational forces do not always apply. What's down can go up, the dead can live again, and the most vibrant gymnast can finish a graceful arc up with a clumsy swing down to oblivion.
The past year has been populated with the undead, an upside-down world where
is now king. The provider of communications systems to large businesses plunged 80% in 2002, only to turn around and advance better than 400% in 2003.
A spinoff of the still mostly moribund
, it has performed the neat trick of becoming the top stock in the
, one year after being one of the index's worst.
Avaya had many companions on its journey from the netherworld, as the second-, third-, fourth- and fifth-best S&P 500 stocks this year all took the same path:
is up 260% this year, after an 88% decline last year.
is up 255% this year, after a 74% decline last year.
Wholesale energy supplier
is up 240% this year, after plunging 95% last year.
, a maker of fiber-optic products, is up 233% this year, after sinking 63% last year.
The Hunt Is On
You can bet this feat will recur in 2004 with some of the big losers of 2003. Which ones? To start our hunt, I've combined the feathered flops from
my Thanksgiving column with reader suggestions in the table below. All are large companies that underperformed the market, in some cases by a lot.
What's striking about this list of big-cap disappointments is the lack of high valuations, poor returns on equity or extreme debt levels. If you didn't know their names or year-to-date results, you might conclude that this looks like an average group of companies. Nothing shouts disaster.
And that's the way it often goes with shunned big-caps that are former highfliers. They obviously once had something on the ball, or they would never have grown to a tremendous size. But somewhere along the way, they blew a couple of quarters in a row, and earnings-momentum investors lost faith.
Then perhaps they overstepped the bounds of business ethics and law by stretching results and got into accounting or legal trouble. At that point, confidence suffered, and panicky employees made dumb mistakes. A decline in morale often leads to lackluster product innovation and the exit of key executives. A couple of years go by, and you notice the companies and their stocks have fallen into a lifeless stall -- ignored by growth investors, but not nearly cheap enough for deep-value investors.
The Four-Phase Life Cycle of a Stock
This process offers a window into the four-phase life cycle of most stocks. Some fade at this point and never revive. But most others become targets of opportunity for the value crowd at some point.
- Accumulation: At first, the vultures' buying of the wretched is slow, smelly and stealthy. If detected by more aggressive market players, it's ridiculed as stupid and hopeless. It shows up as a saw-toothed flat line on a chart that once only tilted down. This is the quartile of the stock life cycle known as "accumulation," and it can persist for months or years.
- Markup: As the deep-value guys patiently build bigger stakes of 5% to 10% or more, their peers take notice, and the arrival of tag-along value buyers generates modestly levitating prices. At some point, if the value guys are right, business fundamentals under new management start to get traction, growth-at-a-reasonable-price buyers move in, and prices start to move up at a modest angle. This is the markup phase.
- Distribution: Then stocks with the best recovery stories -- usually with a raft of new products and executives who know how to play the public relations game -- attract earnings-momentum and price-momentum players who push prices up at a much steeper angle. Eventually, the value funds begin to take their early-bird reward and feed the stock out to latecomers, usually the public, in a period known as distribution.
- Markdown: At this point, the stock is still at highs amid an era of good vibes and high-fives. Online message boards are lit up, and fund managers chirp about unending growth prospects. Yet the stock is oddly losing upward momentum. The price hits a new high, falls back, then hits the same high, only to fall back again. And then it makes one last lunge up, which fails. After this double- or triple-top, the stock collapses into the last quartile of the cycle, called markdown. This is the swiftest and ugliest phase, when shares cascade down in a few brutal days, then sink gently but steadily for weeks or months more, leaving the public wondering what happened.
All of the stocks in my table are either in the markdown or accumulation phase. Most of us would prefer to catch a stock in the markup phase, because we don't have the stomach, vision or insight to be deep-value accumulators.
But one gentleman who does is Thomas Kahn, a New York-based private money manager who last year, and the previous year, in my column suggested that readers consider network-equipment maker
, which was then much hated at $4 (it's now $8); cell-phone maker
, then much hated near $6 (it's now $14); medical imagery-equipment maker
, then hated at $7 (it's now $15); and
New York Community Bank
, then not hated but largely ignored at $17 to $19 (it's now $35).
Benjamin Graham's Grad Student
Kahn, who is so old school he actually worked with Benjamin Graham as a grad student, thinks the market is highly speculative at the moment and grouses that investors failed to learn their lesson from the bear market.
"People obviously haven't lost enough money," he said. "They're supposed to have learned that you're not supposed to buy stocks irrespective of price, or jump into stocks just because the market is going up to make a short-term profit."
Refusing to buy Ford Escorts for the price of a Mercedes-Benz, he and his partners have been net distributors of stocks in the run-up of the past few months. They anticipate an opportunity to deploy their cash in the next panic, but they're in no hurry and are willing to underperform the market temporarily -- for months or years -- as they wait their turn to buy dollars for 50 cents.
Yet there is one group Kahn Bros. is accumulating right now: The much-reviled large drugmakers --
Here's what he says about these -- listen closely to the voice of a successful vulture, the voice of an accumulator of stocks at their lows, the voice of antimomentum:
We like the big drugmakers because we think the time to own these companies is when everyone thinks the pipelines are thin, not when they've just discovered a cure for cancer. We don't know how you get hurt by taking your money out of a money-market fund earning 1% and putting it into Bristol-Myers where it gets a 4% dividend yield, plus potential capital growth in coming years. They've had problems, sure, but they're working through them. You need to be patient as an investor. Don't buy Bristol for this year, buy it now for what it'll do for you in 2006 or 2007. If you buy it now, you get a free call option on the millions they are spending on research and on investments in small biotech firms.
Anyone should be happy with the prospect of compounding their money 15% over the next five years. If you buy Bristol at around $26.50, you get a big head start by earning 4.2% right off the bat forever. Now you only need the stock to go up 10.8% a year to make your 15%.
I'm with Kahn for a significant rebound in the big drugmakers sometime in the next three years, if not precisely 2004. And along with them, I'll add votes for renewed interest in troubled telecom provider
, oil-and-gas drillers
, and media giant
. They all appear to be under accumulation.
Other ideas: Scandal-plagued
would certainly rebound if the
New York Stock Exchange
reverted back to trading in fractions rather than decimals.
is being touted as a comeback play by premier value manager William Miller at Legg Mason.
And three others not in the table that already have begun to attract more buying interest after three years of decline -- and are thus possibly already in the markup phase -- are tech giants
. I'll watch these in the next year and report back.
Jon D. Markman is publisher of
StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at
firstname.lastname@example.org. At the time of publication, Markman controlled accounts with positions in the following securities mentioned in this column: Merck, Microsoft and Hewlett-Packard.