Those who are worried by the stock market’s rally – or, more specifically, by the probability that its big gains of the first quarter are no more than the harbinger of a second-quarter meltdown – might find their fears stoked further by looking at a list of stocks that helped lead the S&P 500 index to new all-time highs:
• Best Buy (NYSE: BBY), struggling to prevent the phenomenon of “showrooming” from further eroding its margins, is up 112 percent so far this year
• Netflix (NASDAQ: NFLX), the company that was about to be overtaken by other streaming video media businesses, up 80 percent
• Hewlett-Packard (NYSE: HPQ), trying to carve a way forward as the era of the personal computer passes into history and that of the tablet dawns, has bounced up 56 percent after a steep tumble in 2012
• BlackBerry (NASDAQ: BBRY), the smartphone maker looking to find new life with a new operating system, up 26 percent.
The great thing about the stock market is that even its dogs get their chance to shine occasionally – and that is particularly true when the market’s obsession with safety and yield results in stocks like this being priced at such low valuations. It was only logical, given that the market has generally been robust, that at some point investors would begin scouring the landscape in search of bargains and especially in search of deep value plays in companies whose business models might be challenged but that aren’t dead just yet.
For instance, Best Buy is no J.C. Penney NYSE: JCP). True, the electronics retailer may be thought of as stealing a play from the latter’s book by deciding to open a brand-specific boutique within its stores. But the brand in question is Samsung, whose Android-based smartphones are displacing Apple’s iPhone as the most popular communications device on the market. And Best Buy is combining this with what early signs suggest is likely to prove a successful cost-cutting initiative; the company’s new CEO, Hubert Joly, also has undertaken new training for employees, teaching them how to offer extra value to shoppers and transform browsers into in-store buyers.
J.C. Penney cut its dividend amidst a dramatic deterioration in its financial results; Best Buy reported a much narrower loss than analysts had expected and a much larger increase in same-store sales for the fourth quarter and kept its dividend unchanged. Sure, former CEO Richard Schulze may have had some problems putting together a buyout offer for Best Buy, but that probably has more to do with the kind of upside guarantees that backers of such a buyout would have wanted in order to forge ahead.
At Best Buy, the path ahead is clear: Joly has spelled out in detail what he plans to do in order to transform its retail outlets into more profitable and higher-growth sources of sales. There is no mystery about what will happen next; the only question is whether Best Buy can execute on this vision. If it can, then clearly the kind of “catch up” rally in the stock may prove well justified. But investors showed that they wanted to wait until they saw at least some signs that such a turnaround might be feasible, and not just take it all on faith.
The case of Hewlett Packard is a little bit more complicated. It is Dell (NASDAQ: DELL), not HP, that has been in the spotlight as founder Michael Dell fights a headline-grabbing, three-way battle to take his company private. HP, however, rallied sharply in the first quarter based not only on the company’s release of better-than-expected earnings in February but on CEO Meg Whitman’s insistence that this was the tip of the iceberg. Whitman’s credibility among investors earned the company’s stock a few extra percentage points of return when investors went bargain hunting.
A selloff hit HP’s share price earlier this week on news that Goldman Sachs analyst Bill Shope downgraded the stock, arguing that the improvement in market sentiment has now outpaced an improvement in the company’s fundamentals. Shope, who slapped a “sell” recommendation on HP’s stock, argued in his note to clients that the weakness in the PC market is likely to undermine the company’s attempts to revive its overall sales by emphasizing products like servers, or any upside from restructuring.
Some naysayers are still circling around Netflix, which has been on a tear since last autumn, rallying 150 percent over the last six months. Wedbush Securities Managing Director Michael Pachter pooh-poohed the company’s prospects on CNBC Thursday, arguing that the company isn’t about to become the next HBO by wowing viewers with high-quality original content. It also remains to be seen whether the company can hang on to all the new subscribers that it has attracted over the last several months. True, Netflix was able to deliver a surprising profit thanks to that unexpected boom in new subscribers – but to naysayers, the tremendous rally is just another sign of a frothy market.
Each of these companies faces significant business challenges, which they will need to address clearly and publicly if investors are to continue to give them the benefit of the doubt. At the same time, to the extent that they or other companies are priced at irrational discounts, simply deciding to avoid them as too risky may also be the wrong move.
Buying value stocks – especially companies that once were high profile for all the right reasons and now must struggle to win a degree of respect – is a particularly tricky pastime. But as the first quarter’s results have shown, it can certainly pay off. The real lessons to draw from these turnaround tales are slightly different, however. First of all, don’t extrapolate too broadly. True, the retailing sector has struggled in trying to compete effectively against online stores, but that doesn’t mean that all bricks and mortar retailers are doomed. It just means that there is an additional layer of risk involved when it comes to investing in companies like Best Buy.
Similarly, dismissing Netflix and Hewlett Packard as little more than “busted technology companies” whose business models have been superseded by those of newer businesses, from Apple or Samsung to Google, Facebook and others, is overly simplistic.
There’s a lesson on this front that investors could learn today. Take a look at Apple, for instance: Like all of these first-quarter winners, the company is a former market darling that now can’t catch a break in the eyes of investors. But should it really command a lower price/earnings multiple than AT&T, Safeway or even Best Buy? It’s hard to rationalize that – except to say that just as greed has helped these winners post the last several percentage points of their blockbuster 2013 returns, it is fear that is keeping investors from betting that Apple can do likewise.
Is it probable that Apple’s new products will never again generate much buzz or interest among consumers or that it will never develop a plan for all its cash that will satisfy investors? I’d suggest not – meaning that there is at least one more deep value investment candidate out there that may end up outperforming.