52 Week Lows: Treasure Trove of Value Investing Ideas

One of the most important tasks for value investors is to set up a system to generate investment ideas, which upon further investigation might be acted upon. One way to get investing ideas is to subscribe to newsletters or stock recommendation services, which provide a periodic stream of investment ideas and analysis explaining the rationale for their recommendations. For do-it-yourself investors, there is a need to figure out a system which throws up ideas, which can quickly be evaluated to see whether they meet their investment criteria.

In this post, I would like to cover one potential source of ideas for the deep value investor. The idea is to regularly look at lists of stocks making 52 week lows in the day's trade. Most financial websites publish such lists. As a strategy, it would be classified as a contrarian play. For users familiar with RSS technology (really simple syndication), I have created an RSS feed, which pulls names of stocks from the www.economictimes.com list of 52 week lows. It is available here. In my experience, this list throws up at least 3-4 stocks everyday. Most of the times, I come across stocks which belong in the list and have no business being part of a value investor's portfolio. But occasionally, this will unearth a wonderful company which has fallen on bad times. A quick click-through leads to a page listing the financial snapshot and ratios of the company.

The rationale for recommending this approach is that for any value investor, the margin of safety and downside protection that the investment offers is very important. The investment return is a function of 2 variables - purchase price and earnings growth. The lower the purchase price (i.e., the higher the discount of the stock price to the stock's real worth), the higher the potential upside, as the potential for appreciation is much higher. Also, as the stock would already have suffered a steep fall, the potential downside gets reduced by the extent of the fall.

Think of it this way, a company trading at a P/E of 20 has to keep maintaining a high earnings growth rate to continue to deserve the same P/E multiple. When it fails to deliver such growth, the P/E multiple falls. This is when the stock price starts to fall. The reason for the fall might be two-fold. Either, the company is unable to sustain its high growth rate because of a high base effect, or it has run into some serious difficulties which have eroded the market's confidence in the stock.

It is usually the latter case that causes a company stock to fall low enough to hit the 52 week low list. This is when smart-money investors who see value in the company through a potential turnaround, management change or acquisition start to enter the stock. These are usually the people who extract the maximum returns out of the stock.

By no means am I suggesting that every 52 week low stock merits the consideration of a value investor. Once an attractive candidate is spotted in this list, the value investor must investigate further to try and understand the reasons for the fall in the stock price. The next step is to evaluate the company's management (is it capable of turning around the company), financial position (does it have too much debt), etc. Failing this analysis, an investor might be trapped in a falling knife scenario, where after each purchase, the stock falls further, and the investor makes more purchases in an attempt to lower the average purchase price. This is a very dangerous scenario to find oneself in.

Food for Thought: By the same, does it imply that if any stocks an investor holds starts to flash in the list of 52 week highs, then it is time to sell them? The answer is that it is not necessarily so. If the company is able to increase its earnings at a fast enough pace (and this depends on the investor's analysis of the fundamentals of the business), then the stock might merit being a hold. But, as a value investor, I would certainly be wary of taking fresh positions in it.

Vivek Iyer