In a long-term diversified portfolio, you should make room for potential multi-bagger speculative stocks. I don’t mean a few small caps or micro caps, which you should always have, but a couple of speculative stocks the market just hates and that have potential to return multiples on your investment.
These speculative stocks all carry a lot of risk, because they are dependent on various factors that are keeping them from taking off. It may be simply a matter of operating in a highly fragmented space that will take years before the company scales. It may be the company has fallen on hard times and there is little faith it will survive. It may be subject to interest rates that have turned market sentiment against it.
The story may be different for each one, but the idea is the same: The market hates the stock now, but might very well love it in the future. You just want to get in before the switch.
Here are three speculative stocks. The good thing is they are all very cheap on an absolute dollar basis, so you can buy in bulk, as long as you’re mindful of the risk.
Speculative Stocks: Chimera Investment Corporation (CIM)
Chimera Investment Corporation (CIM) is an mortgage REIT. CIM stock invests in an area many investors are scared of because they contributed so heavily to the mortgage crisis: mortgage loans, mortgage-backed securities, commercial mortgages, and a whole basket of other kinds of loans.
They may be first or second liens, drawn on residential properties, industrial properties, multi-family properties, offices, and may be investment grade or non-investment grade.
CIM stock plays in multiple tranches of debt, collateralized debt obligations, and most are non-agency backed — meaning the federal government does NOT back them.
I think CIM stock trades below its book value of $3.35, because it has missed SEC filing deadlines several times, which has spooked investors. CIM stock pays $0.09 per quarter, which comes to an 11.2% yield, and the company generates the cash necessary to pay the dividend. So I think you’ve got a very attractive speculative stock here.
Speculative Stocks: Consumer Portfolio Services (CPSS)
Consumer Portfolio Services (CPSS) is a speculative stock that offers financing to subprime consumers to purchase automobiles, through a nationwide network. Due to the fact that the borrowers are subprime, CPSS stock is able to charge high APRs on the loans, which are collateralized by the autos.
Beyond generating revenue through those direct loans, CPSS stock also purchases portfolios of other car loans, and generates revenue by servicing and collecting on those loans.
With any large loan business, there’s yet another way to go, which is to bundle all the loans together and sell bonds against them. That’s called “securitization”. CPSS stock thus raises a huge amount of money by selling those bonds, pays interest on the bonds, and uses the money to make new high interest loans.
The market has this company trading around $6.65. Operating cash flow triples year after year, there is no capex to speak of, and CPSS is growing EPS at 20% annually. With FY14 expected to deliver earnings of 88 cents per share, this is a $17 stock trading for less than half that. You’ll have a tough time finding other speculative stocks with this much obvious potential.
Speculative Stocks: Office Depot (ODP)
What about the tough times over at Office Depot (ODP)? ODP stock trades just above $5 — up from its $3.84 52-week low. The office supply sector is in huge trouble, as online retailers are grabbing market share and doing so without the brick and mortar business, making everything in the sector speculative stocks. It’s analogous to what happened with Circuit City.
Interestingly, ODP stock’s balance sheet is just fine, with cash and long-term investments totally offsetting long-term debt. So ODP stock isn’t going bankrupt. However, it was FCF negative both last year and in the TTM. The company has also seen losses in FY12 and FY13, and through the first half of this year.
The reason the stock is off its lows, however, is because it merged with OfficeMax and has been closing stores like crazy. Merger synergies are expected to reach $700 million by 2016. So a turnaround is in place, and I think there may be upside here, but ODP stock certainly falls under the speculative stocks category.
Lawrence Meyers does not own shares in any company mentioned.