Invest in the Feds Index, the worst performing stocks!

Dan Ferris - Fri 12 Mar, 2004

...Invest in the Feds Index...The Feds Index doesn't have a monopoly on these stocks. There were plenty of companies that did lousy last year and made plenty of money for investors...

Invest in the Feds Index, the worst performing stocks!

It certainly pays to invest in quality businesses.

Wall Street’s S&P 500 index includes some of the greatest business enterprises ever created: Microsoft, ExxonMobil, Wal-Mart. All the big names are there.

Those 500 big names earned investors an average of 28.7% in 2003, an excellent one-year return. Many US pension plans invest in the S&P 500 index. So a vast number of investors did well investing in those companies that most people agree are the safest places for your money...

...but you could have made twice as much money last year simply by focusing on those companies that failed miserably. Some of them actually turned out to be staffed by criminals!

That’s not a typo error. I just said that the worst failures, the US companies run by the most devious managers, made investors twice as much money in 2003 as the most successful businesses, run by the most capable managers. If you break out the top 10, 20, or 30 stocks in the S&P 500, the results are similar. The worst businesses made more money for investors than the most successful businesses.

The stocks I’m talking about are the components of an index called the Feds Index. The equity investment department at Guardian Life Insurance Company created the Feds Index. It's a list of several companies that are under investigation by the US federal government and/or the Securities Exchange Commission for possible wrongdoing.

Invest in the Feds Index, the worst performing stocks: The companies

The Feds Index contains stocks like Tyco, formerly headed by the now infamous Dennis Kozlowski. Also in the Fed Index are El Paso, HealthSouth, Qwest, Symbol Technologies and Computer Associates.

HealthSouth, for example, was down 98% while under investigation for accounting fraud. But it staged a miraculous 5,365% comeback. It’s still rising, even though the size of its fraud has been raised from $2.7 billion to as high as $4.6 billion.

The Feds Index doesn't have a monopoly on these stocks. There were plenty of companies that did lousy last year and made plenty of money for investors. Williams Cos. fell as low as 78 cents a share in the post-Enron energy meltdown. It had to sell billions of dollars worth of valuable natural gas assets to survive. Within a year, it had climbed as high as $9.

AmeriCredit Corporation, the company that buys ‘sub-prime’ car loans [consumer financing with a high risk of default], fell as low as $1.55. Management got its act together and it’s now at around $19.

Invest in the Feds Index, the worst performing stocks: Nobody wants to own them!

The reason why lousy companies bring you great returns is simple. Since nobody wants to own them, their share prices get far cheaper than those of the popular, successful companies most investors want to buy.

Right now is an especially good time to focus on the losers. A year-long rally has pushed many stocks up so that they’re either overvalued or simply no longer cheap. There isn’t much worth buying today...except the failures and criminals.

To find the next Gateway, HealthSouth or Williams Cos., set your favourite stock screener to find “meltdowns”. Look for companies trading at huge discounts to book value. There are a several US insurance companies out there that fit this bill. Insurance premiums have been up the past two years, after falling for two decades. I found one that has taken its share of licks in Hurricane Andrew and again on 9/11. It’s still below my maximum buy price today.

Besides big discounts to book value, you can usually set a stock screener to show you all the stocks that have fallen by a given amount during the last 52 weeks. Look for those that have fallen at least 50%. Remember, you want the worst, not the best.

One caveat: You’ll want to be careful once you start looking for companies that have failed in some way. You’ll find some real garbage, including companies that have declared bankruptcy. They have a letter ‘Q’ on the end of their trading symbol. Oglebay Norton, for example, now trades under the symbol OGLEQ. Gadzooks is now GADZQ. Ignore the bankruptcies and move on.

Focus your efforts on finding the beaten down companies that have enough money and/or net assets to survive. If you do that, I think you’ll do much better over the next year or so than the vast majority of investors.


Regards,

Dan Ferris
for The Daily Reckoning

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