Smart investors know that once the conventional wisdom is established, it’s time to start looking for contrarian ideas. And right now, there’s few things that market participants agree on more than the notion that global economic growth is about to fall off a cliff. This might well be the case — but what if it isn’t? If the world economy suddenly catches the market off guard by stabilizing at level of slow but steady growth, the recent collapse in valuations creates the fuel for a major rally. This is especially true now, as we exit September and inch closer to the seasonally strong period between mid-November and New Year’s.
Given the market’s tendency to catch the “crowd” off-guard, it’s time to start putting together a list of stocks that can outperform in the scenario laid out above. This is undoubtedly a risky group, but these names are likely to be an excellent source of beta if investors catch a whiff of steadier growth.
- 12-month forward P/E: 7x
- Drop from 2011 high: 37.2%
Click to EnlargeThat’s right — the first stock on the list is a European bank. But Banco Santander (NYSE:STD) is no ordinary European bank — as the company took pains to point out with a full-page ad in Barron’s last weekend, 88% of its profits are generated outside of Spain, and 51% come from outside of Europe altogether. Santander is a strong, well-capitalized global bank that has some exposure to Spain, but less than its price performance would indicate. There’s no doubt that as long as the European debt crisis remains in the headlines, the stock will face headwinds. But with a 7.5% yield, a 7 P/E and a price-to-book of 0.49, much of the bad news already has been discounted into the stock price.
Santander — with a beta of 1.83 — is a fast mover, and one with a history of generating strong returns when worries dissipate. Its shares rose about 250% in the nine months that followed the 2009 bottom, and they rebounded over 60% within two months when the first round of Europe-related worries lifted in the summer of 2010.
- 12-month forward P/E: 4.6x
- Drop from 2011 high: 57.4%
Click to EnlargeWith shares trading at $1.53, versus the high 20s back in 2005, Banco Popular (NASDAQ:BPOP) — the largest commercial bank in Puerto Rico — looks like a stock destined to disappear. In fact, BPOP actually is very healthy — and very undervalued. The company has a large (40%-plus) share of the nation’s deposits after a wave of industry consolidation has removed several of its competitors, a positive for its net interest margins. On Thursday, Popular sold a portfolio of construction loans — an long-anticipated transaction whose delay has put a modest cloud of uncertainty for the stock. The company also has a stake in a transaction processing company that accounts for nearly 40% of its current share price.
Popular, which trades at under 0.4 times book value, has dropped off the radar after being a “story stock” in the middle of the last decade. It’s risky, but it stands to benefit from both organic growth and, if economic fears subside, there is room for significant valuation expansion. The average analyst price target is $3.50, 78% above Thursday’s close.
- 12-month forward P/E: 6.7x
- Drop from 2011 high: 50.5%
Click to EnlargeLike many infrastructure plays, General Cable (NYSE:BGC) — which makes large power cables for electricity transmission — has been hit hard by concerns about slowing government spending. These fears, while legitimate, obscure the longer-term story. As the emerging markets’ population grows, the demand for greater power distribution will increase in kind. BGC, with a large emerging-markets business, is well positioned to capitalize on this trend. Furthermore, governments can only hold out on upgrading their power infrastructure projects for so long before older systems will need to be replaced.
These factors help underpinning a steady, longer-term growth outlook for General Cable. Consensus earnings estimates for 2012 have barely budged in the past 90 days, falling from $3.75 to $3.64, which is a much smaller decrease than most companies have experienced. Estimates for 2011 are at $3.03, which puts the company on track for 20% growth next year.
With a low P/E, a stock price at 0.76 book value, solid growth potential, and — perhaps most important — a large short interest at 13.7% of the float, BGC looks ready to outperform in any broader upturn in the markets.
- 12-month forward P/E: 9.9x
- Drop from 2011 high: 43.6%
Click to EnlargeShipping is the sector everyone loves to hate, and with good reason. Stocks of the dry bulkers have been vaporized by a perfect storm of rising industry capacity, plummeting day rates and the effects of the economic slowdown in China and elsewhere. This is a tough sector to trade, but with shares down so far, it’s time to start preparing for the eventual turn by sniffing around for the likely survivors.
Diana Shipping (NYSE:DSX), which has positive net cash and a return on equity above the industry average, fits the bill. Diana Shipping’s attributes make it one of the more expensive stocks in the sector: its shares for 9.9 times 2012 estimates, well above Dryships’ (NASDAQ:DRYS) 3.8. At the same time, however, DRYS is saddled with $3.5 billion in debt and poor management. On that basis, DSX looks like the better option.
Diana’s more conservative nature makes it one of the lower-beta plays within its sector (at 1.55), but any hint that growth is “less bad” than expected will release significant upside from this coiled spring. As the chart shows, quick 50% moves were commonplace prior to the 2007-08 crisis.
Higher-beta stocks undoubtedly will continue to get chopped up if the market goes further south, so extreme caution is in order given that the major indices are in a precarious technical position. At Thursday’s close, the S&P 500, S&P MidCap 400 and Russell 2000 indices were all within 4.2% to 4.3% away from their August lows. If the previous lows are breached, all bets are off for these stocks and anything else with a ticker symbol. With that said, consider these four companies a risky proposition — but one with substantial upside if the consensus call for a global recession proves misguided.