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These well-known names in the bargain bin may look appealing, but experts advise avoiding them until their earnings picture is clear
Welcome to the 2008 third quarter—and a big summer clearance sale on Wall Street. Amid a broad stock market slump, many brand-name companies that we know so well, such as Ford (F) and Motorola (MOT), have been tossed in the $10-and-under stocks bin.
But wait—there's more. Other big names that are trading below $10 are Sprint Nextel (S), Washington Mutual (WM), Del Monte Foods (DLM), and many airlines including Northwest Airlines (NWA), UAL (UAUA), Delta (DAL), and JetBlue (JBLU). (For a list of more names under $10 see the accompanying slide show.)
And one more illustrious name joined the single-digit list: General Motors (GM), which touched a 53-year low of 9.98 on July 2.
The Stigma of Low Stock Prices
What's the big deal about low stock prices? First, there's a certain stigma attached to a stock with a sub-$10 price—it's a sign that a company faces big problems. Besides the blow to a company's pride, there's a more nettlesome issue: Some institutional investors won't touch stocks that trade for less than $10, making it difficult to recover from those depths.
The common problem for most of these stocks: dismal or no earnings growth. "The market price of a stock is ultimately driven by earnings over the long term—that's where you need to start," says Jim Huguet, president of money manager Great Companies in Tampa. "The reason they're where they are is because of lack of earnings growth or earnings have declined, in some cases due to the business or management."
A weak economy, or problems in a particular industry or inside a company may be too hard to overcome, leaving a stock wallowing in the single digits for a long time. For example, the low-flying airlines face high fixed costs for planes and labor, plus the crush of soaring fuel prices, Huguet says. In this kind of commodity business, very few companies have an advantage and are able to boost sales and earnings.
Investing in One Customer Strategy
Some companies, such as Ford and Motorola, can invest too heavily in one customer strategy, leaving them unable to respond when customer demand and needs change, says Graham Hales, chief communications officer at brand consultant Interbrand. Ford focused on sport-utility vehicles and trucks during a time of fuel price uncertainty, environmental concerns, and a slew of cheaper, foreign alternatives, he says. Motorola bet heavily on the RAZR wireless handset for five years.
"Both Motorola and Ford have failed to bring new products to their largest markets, North America and Europe, while competitors have successfully [eaten] away at their leadership position through new products and better brand management," Hales says.
In turn, Ford and Motorola were two of the biggest decliners in Interbrand's most recent Best Global Brands ranking -- losing 19% and 9% from their brand values, respectively. This shows that brand values are linked to stock prices, Hales says. Now both companies will have to figure out ways to reinvent themselves again to stay alive, says Michael Farr, president and chief investment officer of Farr, Miller & Washington in Washington, D.C.
One big brand that's starting to show glimmers of hope is Sprint Nextel (S). Last week its shares jumped 13% on talk of a turnaround, despite heavy selling in the markets. Sprint, which hit a low of 5.48 back in March, rose another 6%, to 9.50, on June 30.
The BlackBerry Example
Since the dot-com bubble in 2000, a few big technology brands have recovered from a slump into single-digit territory and are now thriving. Apple (AAPL), now trading at 171, was under $10 in the summer of 2003. BlackBerry maker Research in Motion (RIMM), which was meandering under $10 between 2001 to 2003, now trades for 118.
"BlackBerry is a perfect example of a brand that recognized that modern business increasingly required employees to be in touch across a number of digital platforms continuously," says Hales at Interbrand. "It built the perfect device; simple and efficient such that senior management could adopt the product, which in turn reinforced its cachet as a public status symbol for a wider market."
Hales notes that Research in Motion shares trade at more than 50 times the past 12 months' earnings. For the company to deliver that level of growth, he believes that RIM will have to invest in capacity and fixed assets to meet customer needs. "The challenge is to avoid taking a position which is too heavily invested in the current paradigm as Motorola and Ford have done," Hales says.
Patience Not Necessarily a Virtue
When good old-fashioned earnings growth doesn't do the trick, some companies will resort to other measures to get out of the $10-and-under bin. Back in November, Sun Microsystems (JAVA), which was trading at around 5, did a 1-for-4 reverse stock split, presumably to boost its languishing stock and get institutional investors to notice its turnaround. But now Sun's stock is once again flirting with $10.
Indeed, some of these stocks are priced so low you might think you're getting a bargain, and that the once-lofty shares will eventually recover. Huguet says if a company's earnings are rising at less than 8% to 9% a year, then the stock will underperform both the S&P 500 index and bonds. "Don't be patient if earnings are not growing," he says. "Patience doesn't reward you."
Fellow money manager Farr agrees: "There's enough risk in the market now given the economic environment that it probably doesn't make sense to reach for these fallen angels in the hope of a rebound." Just remember, single-digit stocks are priced that way for a good reason.
Click through BusinessWeek.com's slide show of several brand-name stocks currently trading for less than $10.