Today I want to talk about the walking dead.
Not the TV show, but the Wall Street version. I’m talking about those stocks that have languished at the bottom of the barrel and are suddenly—and surprisingly—coming back to life.
Lumber Liquidators (LL) is just one example of this kind of stock: Back in March, “60 Minutes” featured an expose that lambasted the company for selling Chinese flooring that contained carcinogenic levels of formaldehyde.
The scandal sent share prices off a cliff, and only around August did the stock finally hit a bottom at $11.62—a full 83% decline from its February 25 high.
After LL announced its recent settlement with the Justice Department, the stock shot up more than 25%, which is a tempting tailwind to position yourself behind. A few brave souls saw this as their opportunity to jump in, thus lifting the share price for the first time in months.
Zillow (Z) was up for a time early last week, popping nearly 6% to hit a new 52-week high just above $35 before falling back below $30 per share this week. The stock was left for dead just a few months ago after CFO Chad Cohen stepped down, but has since shown signs of vitality after acquiring rival website Trulia (TRLA).
Even El Pollo Loco (LOCO) made some huge gains, soaring 19% before pulling back slightly this week. Valuation is still cheap and in my opinion the stock is oversold—but let’s be real, if you look at quarter-to-quarter earnings, the levels have continually decreased.
So while these seemingly-spectacular bouts of momentum may seem appetizing, here’s what is really happening. Bigger, more popular names that have typically been stable performers were slammed hard in last month’s correction. Now that they’ve hit new lows, the bottom-feeders are coming out, sticking their hands all the way down to the bottom of the barrel to fish for profits.
I think there could be potential to make some money playing the rebounds in names like these assuming the market cooperates, but it’s important to keep in mind that these are also the kind of stocks that can go low very quickly if sentiment turns around.
The bottom line is this: these stocks would not have been crushed in the first place if there wasn’t something wrong — something fundamentally wrong — that needed to be fixed.
If companies like Lumber Liquidators enjoy a sustained rally, the message will be to sift through the ash heap for other broken opportunities.
But don’t forget that playing bottom-feeders is always a risky business, and surviving a brush with death doesn’t mean a stock is suddenly worth your investment.
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