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Strategies & Market Trends : Range Bound & Undervalued Quality Stocks -- Ignore unavailable to you. Want to Upgrade?

To: Larry S. who wrote (4278)	4/23/2001 11:48:56 AM
From: Patricia Meaney	Read Replies (2) \| Respond to of 5499

Hi Larry, Don't know if you saw this article yet regarding stocks that have dropped below $10 in today's IBD: >>>Monday, April 23, 2001 Low-Priced Stocks Tempt Novice Investors But Merrill Lynch study shows odds against them being big winners By Ken Hoover Investor's Business Daily You hear it at the gym. And again in line at the supermarket. Your friends at work are talking about it. Those once high-flying tech stocks are cheap. You can get Ericsson for about 5 a share. Ariba is at 7.50. Even once-mighty Motorola dropped almost to single digits two weeks ago. They must be great bargains. Right? Wrong. The leaders of the last bull market make unlikely candidates for winning investments in the next. And low-priced stocks are the worst of all. Merrill Lynch analyst Thomas Watts heard so much chatter about cheap, beaten-down tech stocks being such great buys that he did his own study. What he found won’t hearten investors holding on to fallen angels. He looked at 1,900 tech stocks going back to 1987 that had dropped below 10. He found only 3.4% made it back to 15 the following year. "You hear retail investors all the time say, ‘It’s only a two-dollar stock. It only has to go to 3 to make a 50% profit,’ " he said. But Watts says that’s unlikely. In his own specialty, Internet infrastructure, 13 of 14 companies he follows have dropped to single digits. He thinks about half will go out of business. "Cheap stocks are cheap for a reason," added Morningstar Inc. analyst George Nichols. "Many of these e-stocks are low on cash, and there is concern about their ability to survive." Watts gives three reasons cheap stocks are bad investments. First, it’s harder for a company to raise capital when its value falls. Lenders are reluctant to lend, and investors are unlikely to buy new stock, because the company is less valuable than it was. Second, big investors, like mutual funds, often have minimum capitalization requirements for the stocks they buy. Capitalization is a company’s market value. It’s the share price multiplied by the number of shares outstanding. So as a stock drops, it drops off the radar screens of the big money, Watts says. There’s another reason beaten-down stocks should be avoided: Unsophisticated investors bought them on the way down. Those investors are underwater and would love to get out even. They will be a steady source of supply helping to depress the stock if it tries to rally. Skeptics will point to successful mutual funds like Fidelity Low-Priced Stock Fund. It’s up 4% this year despite a bad market. It has a 77% five-year after-tax return and an IBD 36-Month Performance Rating of B, putting it in the top 25% of all funds. But take a closer look. "Low-priced" for the fund means a stock bought for less than 35. True, it holds many cheap stocks. But of the top 20 holdings reported as of Dec. 31, only one was under 10 last Monday. Only five of its top 100 holdings were under 10. And only 19 of the 100 top holdings had been under 10 in the past year. The manager, Joel Tillinghast, says his big holdings are high-priced because they are his big winners. But he says the world of low-priced stocks can be treacherous. "If you bought all the stocks under 10, that wouldn’t be a winning strategy," he said. "It’s not easy picking low-priced stocks. If you have to do it, maybe it’s better to pick a person that does it all the time." By that, he means find a good mutual fund, like his, to do the stock picking. The cheapest stocks can’t be listed on the New York Stock Exchange or Nasdaq. They trade on the Over-the-Counter Bulletin Board. A new study by DePaul University and American Express took the first empirical look at those stocks. The results surprise few pros. "In general, the risks are higher and the returns are lower," said American Express’s Lawrence Levine, co-author of the study. It looked at Bulletin Board stocks from 1995 through 1998 and found that they underperformed exchange and Nasdaq stocks every year. An example: In 1997, an equally weighted NYSE portfolio was up 24.5%. A similar Nasdaq portfolio rose 17.8%. Bulletin Board stocks lost 4.2%. In his tech stock study, Watts says the data are distorted by what he calls the recent bubble years. In 1999, 11.3% of stocks under 10 rebounded to 15 the next year. That’s because many weak companies were swept up in the buying frenzy. But of the 437 companies that fell into single digits in 2000, only five had come back by April 4, the date of his report. Excluding the bubble years, the success rate would have been 2.9% instead of 3.4%. "People like to talk about famous cases like Chrysler or Citigroup. We’ve all seen companies that fell into single digits, then made dramatic recoveries," Watts said. The point of his study: "The chances of failure are greater. There’s an added obstacle when a stock falls below 10." He notes that stocks that do succeed in rebounding to 15 often go on to become spectacular successes. Like Comverse Technology, which dropped below 10 in 1997. It went on to post a 475% return through March 28, 2001. "There are good companies and bad companies among cheap stocks," Levine said. "What it comes down to is you have to do hard-core fundamental research to tell them apart."<<<