Overcoming the Single-Digit Blues
Wall Street’s latest sell-off is dragging more well-known technology and telecom shares into troubled territory: single-digit prices.
Stocks that fall below $10 can bounce back, but it often isn’t easy, and the struggle can test the patience and fortitude of investors.
Numerous tech and telecom names have fallen well under $10 a share in the latest phase of the 2-year-old market slump, which saw the tech-heavy Nasdaq composite index dive 7.4% last week to end at 1,663.89, the lowest since Oct. 18.
Lucent Technologies Inc., for example, whose shares topped $70 in late 1999, now trades at $4.65; WorldCom Group, another former highflier, is at $3.27; Ericsson, the Swedish phone giant, fetches just $2.43; and Qwest Communications International Inc., which traded above $40 last spring, now is at $5.75.
Though a company’s nominal share price by itself may not provide much help in judging the business’ prospects, experts say several forces begin to work against stocks at single-digit levels--including investor psychology, the companies’ inability to raise new equity capital or make acquisitions using stock as currency, and limits on institutional ownership and brokerage research coverage.
Also, some brokerages discourage customers from buying low-priced stocks.
In the short run, the sheer downward momentum on already depressed stocks can be hard to overcome.
“Sometimes the market reacts to the economy and sometimes the market reacts to the market,” said Thomas Plumb, manager of the Thompson Plumb Balanced mutual fund in Madison, Wis. “These days people are selling a lot of stocks simply because they keep going down. They say, ‘I’d better sell it today before it goes down again tomorrow.’”
With a fundamental recovery in the underlying business, of course, any stock can snap back.
Amazon.com Inc., for instance, which traded as low as $5.51 in October, has surged to $16.91 as the online retailer’s losses have shrunk; chip component maker Conexant Systems Inc., which fell to $6.57 last fall, has risen to $10.14; computer services provider Unisys Corp., which traded under $8 in September, has clawed back to $12.33.
However, history shows that stocks can languish in low single digits for years once they fall to that range. And more than a few that got there over the last two years have been wiped out in bankruptcies.
But for every seller there is a buyer, and some money managers say they have eagerly scooped up stocks such as WorldCom and Qwest at these prices. Buying low and selling high, they say, requires not just a long-term outlook but also a strong stomach.
One big hurdle facing single-digit stocks is the stigma of a low share price.
“Five bucks a share is kind of a first cut for a lot of investors and Wall Street analysts,” said Chuck Hill, research director at earnings tracker Thomson Financial/First Call in Boston. “If the stock is below $5 there may be a suspicion, justified or not, that things have really tanked.”
Some institutional investors face guidelines restricting them from buying stocks under $5. Some brokerages don’t let investors buy stocks under $5 on margin--that is, using borrowed funds for leverage.
Among the reasons for the restrictions on low-priced shares: They can be extremely volatile, and lesser-known names with relatively few shares trading can be susceptible to manipulation.
At brokerage Edward Jones, brokers get no commission when a customer buys a stock below $4 a share, and clients are prohibited from purchasing shares under $1. At rival A.G. Edwards & Sons Inc., customers are warned of the “potential risks” associated with stocks trading below designated levels, the firm says.
Brokerage analysts--whose “buy,” “sell” and “hold” ratings still can sway share prices even in the face of Wall Street’s credibility crisis--often drop coverage of low-priced companies, which they see as unlikely prospects for lucrative investment banking business.
Internet business developer CMGI Inc., for example, was followed by eight brokerage analysts when the stock traded north of $100 in early 2000. Now, just one analyst covers the $1.24 stock.
For many hard-hit tech and telecom companies, even if the business improves, shell-shocked investors may be reluctant to bid up share prices with the vigor of the late 1990s.
“The problem feeds on itself. You can almost equate many of today’s telecom companies with the [crash of the] ‘Nifty 50' growth stocks of the early 1970s,” said Dennis Ferro, chief investment officer of Evergreen Funds in Charlotte, N.C. “Expecting these stocks to return to premium valuations may be futile because it takes a long time to rebuild your credibility with investors. Once burned, investors won’t be as generous.”
Apart from the psychological factors that can keep investors away, a low share price can have a negative fundamental effect on a company, experts say.
A low price inhibits a company’s ability to make acquisitions that might otherwise help the business, Ferro said, because management doesn’t have valuable shares to use as currency.
In addition, single-digit status makes it tough to tap the skeptical debt and equity markets with securities offerings to raise capital, especially at a time like this--when telecom firms in particular face a cash crunch. There also is a concern that even if a new stock offering is completed, it might seriously dilute the holdings of current shareholders.
Still, a low price does not have to be permanently crippling, experts say.
Lucent still is a $15.9-billion company by market capitalization, Hill noted (market cap equals share price times number of shares outstanding). Some analysts believe the networking-equipment giant is headed for a turnaround under its new chief executive.
WorldCom Group, meanwhile, still has $9.7 billion in market value.
Investors with long time horizons say some of these stocks are too much of a bargain to pass up.
“There is tremendous value, but also tremendous risk,” said John Buckingham, manager of the Al Frank Fund in Laguna Beach. “We think the risk/reward profile is favorable.”
Buckingham, whose fund is up 6.2% year-to-date, said he recently has bought such stocks as WorldCom, WorldCom’s MCI Group tracking stock, Lucent, ADC Telecommunications Inc. and Nortel Networks Corp.
He said he keeps each stake at or below a half-percentage point of his total portfolio, however.
“It’s important to have a broadly diversified portfolio of stocks from different sectors,” Buckingham said.
“Anything can go kaput. When you buy it, you have to be prepared for it to go to zero,” he said, noting high-profile bankruptcies such as Enron Corp. and Global Crossing Ltd. in recent months. A record 143 publicly traded companies filed for Chapter 11 in 2001, according to Moody’s Investors Service.
Still, Buckingham said he thinks WorldCom, which has no significant debt maturing until 2003, will be a survivor, and he called the stock a “worthwhile speculation.”
“It looks ugly now but if you wait for earnings visibility, WorldCom is probably a $15 stock,” Buckingham said. “That’s not when you want to be buying it. That’s when I’m going to be selling it to you.”
Plumb, whose fund is up 0.7% year-to-date, said he has been buying shares of three telecom companies that generate “stable cash flow” from local phone business: Qwest, SBC Communications Inc. and Verizon Communications Inc.
SBC and Verizon--whose shares have slumped but remain comfortably in double digits--also pay dividends, Plumb noted.
In the case of Qwest, Plumb believes the firm’s directory and local service businesses combined are worth about $13 a share--more than double the current share price.
Many pros, however, have steered clear of telecom, noting the industry’s heavy debt loads and excess capacity.
“We monitor the progress of the telecom stocks but generally we have a ‘we’re from Missouri’ attitude,’” Ferro said. “We want to see management back in control of the revenue stream. We’re not trying to bet on turnarounds or pick the bottom.”
Jeff Van Harte, manager of the Transamerica Premier Equity fund in San Francisco, notes that if a company goes belly-up, holders of common stock are likely to get wiped out while bondholders can get paid off.
“My advice with these imperiled companies would be: If you’re going to invest, buy the senior debt,” Van Harte said. “You want to get up the capital structure [ladder] as much as possible. In a Chapter 11, the common shareholders are left holding the bag, and that bag is empty.”