Stocks We’re Watching

One of the features of The Kelly Letter
that sets it apart is its willingness to wait long periods of time for the right prices. My readers and I are not traders. We are patient seekers of value.

Waiting is hard to do. My letter is blessed with a high subscriber retention rate. Most people who try it continue using it beyond the trial period. Of the people who do cancel their subscriptions during the trial, most cite low trading activity as the reason. They are looking for action and my letter simply doesn’t provide much of it.

For instance, we’ve been watching five companies for months. We haven’t bought any of them yet. This week, I added a new name to the list: Investments are shown only to KELLY LETTER subscribers. Click to try the letter for one cent.
with an initial buy target of $6.

Last week went well for us. Two-thirds of the stocks we own rose while the stocks we’re watching to buy either rose only modestly or fell. The online gambling company we’re watching dropped nearly 14%.

The semiconductor maker we’re watching is down almost 30% since we began tracking it. It feels that we should be buying already, but it looks like it has further to fall. The stock dropped on Monday, then rose on Wednesday on rumors that private equity investors are looking to buy it.

About that, American Technology Research analyst Doug Freedman, who has a Sell rating and $12 price target on the stock, wrote, “While we do not doubt that private equity is sitting on cash it needs to put to work, we have a hard time seeing how it would get involved in [the company] at the present valuation. In past cycles when the company has lost money the shares have traded at 0.5x sales, or $8. We are not expecting shares to fall to this level but we are concerned given our $8.8 billion revenue estimate for [fiscal 2008].”

He said that the company is probably having trouble with its arrangement with Dell, one of our holdings. Michael Dell’s return to the helm of his company will probably bring stronger ties to Intel, another of our holdings.

This drama highlights why we own Dell/Intel, and why we’re waiting for a dirt cheap price on the company they’re creaming. It’s important to remember through this that the company under duress is not a wimp. It bested Intel just a year ago, and is now on the down side of the teeter-totter. It will come back. We’re trying to nimbly time our buys and sells of the stocks of the two leading semiconductor makers.

Mr. Freedman recommends waiting longer on the company we’re watching, which we’re doing. He wrote, “We advise investors to limit their exposure to [these] shares until cash is raised and new product benchmarks are made available. We would not be surprised if a discount to $12 is required to get investors to fund the [firm]/Intel price war.”

Our current target is $14, but I could very well lower that based on the price action, as I’ve done several times on the way down from $20.

Onto the newest company I’ve added to our list. This is a high-risk stock, appealing more for its low valuation and turnaround prospects than for its inherent business strengths. It’s important for you to know that as we monitor it. It’s no Wal-Mart; it’s no McDonald’s.

The history of high-risk stocks in The Kelly Letter shows that most lose money, but that the ones that make money make enough to cover for the losses. Our latest addition to the watch list is by no means a core portfolio holding. It is a chance for risk-takers to boost returns with a small portion of their overall portfolio.

With that out of the way, let’s see why it’s of interest.

The company provides electronic manufacturing services. It covers both design and engineering and you’ll find its products in PDAs, computer networks, laser printers, modems, some medical devices, and so on.

It was one of the darlings of the dot com bubble of the late 1990s, and fell 85% in the ensuing crash. For the past five years, the stock has been on a gradual path lower as management has restructured.

The stock has been pummeled. It’s down 40% in the past year, 34% in the past three months, and 19% in the last one month. According to Thomson Financial, on days when the market is up, this stock tends to perform in-line with the S&P; 500. On days when the market is down, the shares generally decrease by 32% more than the S&P; 500. Its 52-week low of $5.79 came on Feb. 1. It closed Friday at $6.44, only 11% above that low.

Its statistics are atrocious, hence the plunge. Its trailing P/E is undefined because it lost money. Going forward, however, its P/E is just 13. Aha! That’s the spark of interest.

For the first time in years, analysts are forecasting a steadily increasing earnings trend for the next year. Each quarter is supposed to produce incrementally more profit than the last, a picture-perfect up slope. It’s a little early to say for sure that the shares are on the mend, but they are giving hints of that and the future looks mildly positive for the first time in a long time.

Here are the per-share earnings estimates:

Quarter 03/07: -0.08
Quarter 06/07: 0.02

Year 2007: 0.13
Year 2008: 0.51

For next year, analysts forecast 292% growth.

Some 7% of shares are owned by insiders, not great but not negligible, either. The company has debt, but not a crushing amount. Its debt/equity ratio is 0.4.

In late November, with the stock at $9.68, the company appointed a new president and CEO. The stock kept dropping:

  • 12/15: $8.04 Thomson Financial upgrades from Hold to Buy
  • 12/21: $7.74 Nesbitt Burns upgrades from Underperform to Market Perform
  • 12/29: $7.81 Thomson Financial downgrades from Buy to Hold
  • 02/02: $6.27 Ford Equity Research upgrades from Neutral to Favorable
  • 02/09: $6.34 Thomson Financial upgrades from Hold to Buy

Remember, this is a high-risk idea. We’ll watch for a while to see how price and volume behave, and look for a reasonable entry point.

If you’d like to join us in the hunt for these and other compelling values, please try a one-month, one-cent trial. I hope to welcome you soon!

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