Investors typically follow the same group of successful and popular stocks. The media gives them the most coverage and everyday investors feel safe buying them. As a result, those companies rarely trade below a reasonable estimate of intrinsic value and become quite overvalued when the news flow is positive.
A recent post by Ten Bags Full founder Tim Morris shared a screen of those companies that have suffered major share price drops. By comparing 52-week highs with seven-day highs, Morris collected a bunch of companies that investors have been dumping in droves. What I found interesting was that the vast majority had no earnings, and most of the companies were hopeful resources stocks or hopeless mining services companies. It turns out Motley Fool analyst Scott Phillips was on the money when he resisted calls to recommend mining services companies during the initial sell off last year.
However, a collection of ‘loser’ stocks is fertile ground to find babies thrown out with the bath water. Indeed I suspect Logicamms Limited (ASX: LCM) is just that. The share price is down over 50% from a high of $2.05, despite the fact that Logicamms is likely to survive the mining downturn.
That’s because the company makes most of its revenue – 55% in fact – from hydrocarbons, namely oil and gas. Indeed, the company does business with a number of high profile gas and oil companies such as Santos Limited (ASX: STO), Origin Energy Limited (ASX: ORG) and Oil Search Limited (ASX: OSH).
The Queensland government has given the go-ahead to extensive coal seam gas production in fertile farm land. The incentive to extract this gas is high, because the new LNG export facilities will expose Australia to the international gas price (that’s why gas prices will go up, not because of environmental legislation). However, increasing awareness of the potential for contamination of aquifers by CSG wells is likely to lead to fairly high standards of regulation, which is good news for an engineering company like Logicamms. Indeed, Santos has already paid a fine for contamination of what the Santos hydro-geologist claims is not an aquifer but a ‘shallow perched layer.’
Another profitable company that is currently out of favour is Wotif.com Holdings Limited (ASX: WTF). The company specialises in hotel bookings, though it also sells flights. Because it has become clear that Wotif is no longer growing (in fact, probably shrinking) the share price has dropped over 50% from its 52-week high. However, I should note here that the stock’s 52-week high was nothing short of ludicrous, so I think it would have to drop a little bit more before it could be considered a bargain. Wotif’s problem is that – despite having the best brand in its niche – it faces competition from overseas rivals, domestic rivals and the ‘sharing economy’ (think AirBnB). These factors mean that less people use the site to book.
Having said that, the company has particularly impressive brand recognition and trust. Trust is important when making internet bookings, especially among the older generations, who are less adept at telling the difference between a scam site and a legitimate site. The business model is also very light on capital requirements, the company has no debt, and is able to benefit from pre-paid bookings which become a sort of float. Therefore, higher interest rates actually benefit the company noticeably. There can be no doubt that the business appears to be in secular decline, but it is far from game over for Wotif.
The third heavily sold down company that caught my eye is Acrux Limited (ASX: ACR), a pharmaceutical company that sells testosterone treatment Axiron, and has a newer estrogen treatment called Estradiol. Axiron is used to treat low testosterone, although there’s also the reportedly (underground) market amongst body builders, who seek elevated testosterone levels. Estradiol is prescribed for the treatment of menopause symptoms, but it’s not unreasonable to expect that it too will find a secondary market due to the fact that the chemical is reported to increase both fertility and sex drive.
Acrux has also dropped over 50% since its 52-week highs, and looks to be approaching value, assuming sales growth can be maintained. However, in February this year the company announced that: “On 31 January 2014, the U.S. Food and Drug Administration (FDA) issued a Drug Safety Communication (DSC), which stated that the FDA is investigating the risk of stroke, heart attack (myocardial infarction) and death in men taking FDA-approved testosterone products.”
Given that the FDA is well known to share a revolving door with big pharmaceutical companies, it’s hard to imagine them setting a precedent by banning Axiron. However, these things are difficult to predict. If you’re worried about ethics, the fact that so many people appear to be using the drug for bodybuilding (Google it) might be enough to turn you off. What’s more, there is scientific evidence that long term use of Estradiol can increase the risk of breast cancer, so these drugs aren’t that great in my opinion.
The three companies mentioned above undoubtedly have their problems, but I do believe that contrarian investors might find value there, especially if they wait for the share prices to drop to absurdly low levels (they are already quite cheap). Alternatively, there is clear value if any of these companies manage to solve their problems. In fact, it’s quite possible that the companies’ problems are more a matter of investor sentiment correcting or potentially over correcting from previously optimistic forecasts.
Finally, please be careful when looking at beaten-down companies. For every baby, there’s an awful lot of bathwater. For example, I would never invest in an unprofitable and questionable business like Paladin Resources Ltd (ASX: PDN), which has seen its share price smashed over 50% from 52-week highs. Paladin does not have an attractive long-term business model: uranium mining only seems like a great idea if you ignore Fukushima, Chernobyl and the near-permanent and cumulative liability of radioactive waste.
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Motley Fool contributor Claude Walker (@claudedwalker) does not say "never" lightly and does not own shares in any of the companies mentioned in this article.