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Stock Screen
Go Ahead, Hit Me Again
By Cintra Scott
June 21, 2001
OK, WE'RE JUST going to lay it right out there: For this week's stock screen, we decided to look for the stocks investors most hate at the moment. The stocks they scorn. The ones they despise.
This might sound like we've finally lost our minds, but the truth is contrarian thinking can often be a powerful investment tool. Sure, it's risky to buy the stocks everyone else has been selling. But so is buying the stocks everyone loves — consider that current pariahs Cisco Systems (CSCO) and JDS Uniphase (JDSU) were hitting spectacular new highs just a little over a year ago.
The point is, markets do overreact — in both directions. That's not to say some hated stocks don't deserve your scorn. Some surely do. But others may look a lot better once market sentiment shifts. Had we run our contrarian screen last December, for instance, we would surely have turned up Microsoft (MSFT). Having run into the double-bladed buzzsaw of a high-profile antitrust investigation and slowing PC sales, the software giant hit a 52-week low of around $40 — almost 70% off the high it had hit a year earlier. Since then, however, investors have managed to recall that Microsoft has huge profits, enormous market power and a mountain of cash. And this once-hated stock has more recently found the love: It's up almost 70% from that dismal December low.
Looking for similar villains in this market, we tuned our search engines to find companies that are both beaten down and promising. We started by asking for the stocks that have dropped the most over the past year. Of these dogs, we then demanded profitability, above-average historic growth, low leverage, low valuations (based on trailing and current-year price-to-earnings ratios) and promising long-term growth prospects, according to analysts. (See complete recipe.)
Naturally, our results were littered with telecom stocks (see our complete list or download a spreadsheet). After all, what's not to hate in that sector? Having overspent wildly to build more broadband capacity than anyone needs (at the moment, anyway), the economics for this business have gone to the dogs. Earnings warnings from the likes of Nortel Networks (NT), JDS Uniphase, Level 3 Communications (LVLT) and, most recently, Tellabs (TLAB), have knocked the sector's stocks to new 52-week lows seemingly each day. And until the broadband glut is resolved, many predict there's no recovery in sight.
Of course, if the recovery were in sight, the stocks would be pricier. So the time to buy is now, when these stocks are beaten to a pulp. That's thinking like a true contrarian. So we turn our focus to two battered telecom-related companies — tech conglomerate Corning (GLW) and construction-services provider Dycom Industries (DY). There's no question both companies will continue to face difficult times in the coming months. But the stocks may have already taken that into consideration.
Corning
Back in September, Corning hit a 52-week high of $113.29, thanks to its surging sales of the glass fibers used to build fiber-optic broadband capacity. Recently, the company touched a new 52-week low of $12.60, thanks to its languishing sales of that fiber. Truth be told, the company has remained eerily silent about its revenues in these last few weeks of its June quarter. And that silence is making investors very nervous. "In this market environment, investors tend to assume the worst," says Drake Johnstone of Davenport & Co., who follows Corning and its peers.
It doesn't help that Nortel and Level 3 — both customers of Corning's — have already admitted their short-term prospects stink. And naturally enough, analysts haven't waited for guidance to slash their Corning estimates. Current estimates are looking for 86 cents a share in earnings this fiscal year, and that's below the low end of the company's previous guidance to Wall Street.
So what makes us think this stock has any potential for recovery? Well, a couple of things. First of all, Corning is fairly well diversified. Sure, telecom-related revenues accounted for 72% of its $7.1 billion in sales last year. But the company does have other businesses cooking on the side. Once famous for its Corningware and Pyrex brands, Corning currently makes flat-panel displays for televisions and computers. It also manufactures specialty materials and equipment for the scientific, semiconductor and environmental research markets. More diversification translates into less earnings risk than at many of Corning's telecom-equipment peers.
Seventy-two percent is still a big number when it represents exposure to a market in the dumps. But take a look at Corning's valuation — it already reflects much of the bad news. At around $13, the stock trades for 15 times Wall Street's recently reduced current-year earnings estimate of 86 cents a share. That's well below the S&P 500's current multiple of 23 times this year's earnings. Moreover, Corning trades for just 10 times its earnings from continuing operations over the past 12 months — a 76% discount to its five-year average of 41. To look at it another way, the stock trades for 1.6 times revenues, which is safely in value-stock territory.
But Corning is really only a value if it can recover its lost telecom-related sales. On that issue, the Street is cautious about the coming months, but generally positive about the long term. After all, analysts expect Corning's earnings to grow an average of 25% a year over the next three to five years. Fiber-optic-cable sales are expected to pick up, as overseas and metropolitan markets get wired. Right now, Corning is working with three major telecom carriers in China to lay fiber-optic cable across the country.
So far this year, the stock has been downgraded 17 times, according to Briefing.com. Just last week alone, Merrill Lynch was one of five brokerages to lower their ratings. But note that Merrill continues to recommend the company to long-term investors "based on Corning's leading position in excellent long-term growth areas."
Given the short-term storm clouds, Davenport analyst Johnstone wouldn't be surprised if Corning issued a new warning about June-quarter expectations any day now. And that might hammer the stock anew. But he also thinks a warning might be a catalyst for the stock. "It would be a relief," he suggests, "and provide some support for the stock." Waiting for analysts to jump back on the Corning ship would mean waiting for a higher price.
Dycom Industries
Some analysts have a similarly split opinion on Dycom Industries: near-term bad, long-term good. Dycom specializes in construction projects for telecom-service providers. Think of it as the telecom and cable world's ditch digger for hire. That's a rough business right now, as smaller telecoms go belly up and larger ones cut costs.
So what's to like about Dycom? We talked about the long-term outlook with Martin Chang of Jolson Merchant Partners, a research-focused brokerage for institutional clients. Chang thinks Dycom's strategic focus leaves it well positioned for an eventual boom in broadband-enabling construction projects. "Most of [Dycom's] work is on the local loop as opposed to long-haul construction," he explains. And since long-haul connections have been built, "local is where the real work will be coming from," Chang says. The analyst also likes Dycom's client list, which includes large, incumbent carriers and very few competitive local exchange carriers (CLECs). "That's a very different customer base than its competitors'."
Also on Dycom's list of attributes is its balance sheet — "the most conservative in the business," according to Chang. Dycom's debt comes to just 2% of its total capitalization. To compare, its competitors' leverage averages 30%. Also, Dycom manages its balance sheet well with the lowest DSO — that's days sales outstanding — in its industry.
Thanks to deteriorating demand for its services, Dycom shares dropped so much this spring that they're now trading for just 13 times current-year earnings, about half the S&P's average. And at Tuesday's close of $18.35, they were trading at 11 times trailing earnings, or half their five-year average of 22. When rival Quanta Services (PWR) warned last week and lost as much as 41% of its value the next day, Dycom held relatively steady, dropping 10%. Now, that doesn't mean Dycom has necessarily hit bottom — bottoms are only apparent once a stock has climbed out of its hole. "It's hard to go against investor sentiment," Chang says. But sometimes it pays to go against the tide. |
