Digging through the S&P 500’s Dumpster for Value Stock Profit Opportunity

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Submitted by George Putnam, III as part of our contributors program.

Digging through the S&P 500’s Dumpster for Value Stock Profit Opportunity

The S&P 500 has been one of the best performers over the past year among the major stock indices (up almost 17%). But that doesn’t mean that all of its component stocks have fared well. In fact, as investors seem to be getting increasingly nervous about the stock market, when a big-name stock falls short of expectations, or gets out of favor with Wall Street for some other reason, it tends to get crushed. As a result, a number of S&P 500 stocks are down more than 20% over the past 12 months.

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I looked at the bottom performers in the index over the past year, and the four value stocks discussed below all appear to have significant rebound potential for those investors willing to bet against the crowd. They all have solid business franchises, and several of them have powerful brand names as well.

ADT (ADT) has a long history of market leadership in home and business security systems. But it also has a history of ownership changes, most recently being spun off by Tyco in October 2012, and so management has been distracted. In addition, the entry of cable TV operators has provided a new source of competition. Last January, the stock swooned nearly 17% on a disappointing earnings report. Management appears proactive, releasing solid new products and entering promising partnerships with Ford, McAfee and State Farm. And cash flow appears ample to cover debt expense, which has increased with borrowings used, in part, to fund share buybacks.

Coach (COH), probably the world’s most recognizable brand in premium leather goods, is seeking to find the right design/price-point combination as it expands the brand into clothing and other accessories. A new CEO, promoted from within, took over in January, and the company is now transitioning to a new designer. The turnaround initiative includes closing some retail locations and moving out old inventory, and so the next quarter or two may offer more disappointing news. But expectations have been lowered, as has the valuation of the company, and so any positive surprises should generate significant appreciation. And with more than three times as much cash as debt, there is little balance-sheet risk.

Urban Outfitters (URBN) derives the bulk of its sales not from its Urban Outfitter stores (roughly 41% of sales) but from its Anthropologie Group (about 43%) that targets a somewhat older demographic. Sales at Anthropologie are doing well, and demand for the firm’s Free People brand is also quite strong. To be sure, there are headwinds, including subdued economic growth and active competition, but management sees good growth potential in international expansion and the further build out of the Anthropologie and Free People lines. Any turnaround at its namesake stores could lead to solid gains in the stock price.

Whole Foods (WFM) has long been dominant in large-scale natural foods retailing, but it now has more competition nipping at its heels. For the last several quarters, the stock has sold off on earnings reports that fell short of investors’ growth expectations. For example, in May, the stock dropped nearly 19% on second quarter earnings. Whole Foods is responding by lowering some of its price points to be more competitive and by opening new stores. With only about 400 stores, there is plenty of room for further expansion. Margins may be pressured for another quarter or two, but with an outstanding balance sheet and solid brand, I doubt the Whole Foods’ growth story is over.