Thinking a stock is cheap just because its moved lower is a very dangerous game.
It’s tempting to get caught up in the numbers, particularly from this year. Consider that in 2011, the worst pick of the Dow was Bank of America (NYSE:BAC), with a nearly 60% slide in the calendar year 2011. Year-to-date in 2012? BAC is up 90%.
But this alone is not proof that the investment thesis of “last year’s worst will be this year’s best.”
Consider that the worst performer in the S&P 500 index for 2011 was First Solar (NASDAQ:FSLR) with around a 75% decline. This year it has sat out the big rally on Wall Street with another 6% loss. That’s because the industry in general is fighting trends that one company can’t dodge on its own — secular weakness in the alternative energy industry amid relatively cheap gas and oil, painfully low pricing thanks to a glut of supply and a lack of government subsidies amid European and U.S. budget cuts.
Furthermore, the once-popular “dogs of the Dow” theory has somehow turned into the idea of buying beaten-down stocks, when investors really should understand that the premise actually involves selecting stocks based on the highest dividend yield, not on share price declines. Oftentimes that means a big loser is selected — but Bank of America actually was not, since its 1 penny per quarter dividend didn’t give it enough of a yield to qualify. So don’t confuse this popular alliterative idea with the over-simplistic concept of battered blue chips bouncing back.
Of course, past performance is never a guarantee of future returns either way. So do your homework and think logically about each pick based on this moment in time — not its history or a flashy headline on an investing site.
Right now, the worst dog of the Dow in 2012 seems to be Hewlett-Packard (NYSE:HPQ) — and there’s plenty of chatter about why bottom fishing is a good idea in HP now. The yield is about 3.7%, the company continues to cut costs and lay off workers to restructure, and based on a forecast of $3.40 in earnings for fiscal 2013 the P/E is a mere 4.2. What’s not to like? Couldn’t this pick pull off a turnaround like Bank of America?
Maybe … there’s a chance like Bank of America it could see some deep cuts pay off and some favorable industry trends (an uptick in IT spending maybe?) benefit the bottom line.
But there’s also a chance that the post-PC age and a painfully unimpressive restructuring plan will keep this company uncompetitive. Furthermore, we’re still trying to piece together the story of the recent bombshell about Autonomy’s accounting.
In short, the best stocks tend to perform based on their unique strengths and overall industry uptrends — not a track record from the previous calendar year.
- A smart, handsome analyst at InvestorPlace predicted that “The upside for utility stocks has already been had” in 2011, and that they would underperform in 2012. (InvestorPlace)
- What are the best stocks of 2012 and the worst stocks of 2012 in the S&P? (The Slant)
- Some great long-term performance stats on how the Dogs of the Dow dividend strategy works … and seems to work well. (Dogs of the Dow)
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.