3 Battered Stocks to Buy While They Are Down

When a crisis hits, investors tend to sell first and ask questions later. Yet besieged stocks often start to recuperate as the headlines fade and investors anticipate a return to precrisis sales and profits. Stick with these stocks through the hard times and you can reap hefty gains.

The trick, of course, is to find companies that are more likely to rebound from a setback than collapse from their misdeeds. Lululemon Athletica, for instance, managed to recover from an embarrassing episode in 2013, when its new line of yoga pants turned out to be too revealing. A strong brand and loyal customer base helped the firm get back on track. Conversely, no amount of damage control could revive shady businesses such as Enron, which filed for bankruptcy reorganization in 2001 after a devastating accounting scandal.

If you’re going to bottom-fish, be patient. Wait for the stock to settle after bad news hits, and then buy shares gradually over time (in case more bad news trickles in). Home in on companies with durable advantages, such as a strong brand or exceptionally low costs. Steer clear of firms with inscrutable accounting. And look for companies that pay dividends and are likely to maintain the payments through a crisis. Even if the shares don’t budge for ages, at least you can get paid to wait for a rebound, says George Putnam, editor of the Turnaround Letter, a newsletter that focuses on out-of-favor stocks.

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One dividend payer he likes now is SeaWorld Entertainment (SEAS, $13.16). The owner of 11 theme parks, including Busch Gardens, Sea World and Sesame Place, the firm has faced a tidal wave of bad publicity about its treatment and breeding of orca whales. The stock has sunk more than 50% since mid-2014 as park attendance has waned and revenue growth has dried up. (Share prices are as of August 8.)

But SeaWorld should rally, says Putnam. The company says it will phase out theatrical orca shows and end its killer-whale breeding program. It’s launching new rides and attractions. Attendance at its Florida parks has been falling, but traffic at parks in California and Texas is picking up. The company recently reported results that fell short of Wall Street estimates, hammering the stock, and park attendance could ail for a few more months as tourism to Florida falters due to fears of the Zika virus.

Still, analysts see revenues climbing 2% in 2017, to $1.4 billion, with profits rising 22%, to 83 cents per share. For dividend investors, SeaWorld looks compelling, too, paying 84 cents per share annually, giving its stock a 6.4% yield at the current price. Although analysts on average expect SeaWorld to earn only 68 cents per share this year, the company should be able to generate enough free cash flow (cash profits from operations, less the capital expenditures needed to maintain the business) to cover the payout. “The company’s turnaround is taking a little longer to show results than I initially expected,” says Putnam. “But I still like it.”

Chipotle Mexican Grill (CMG, $401.40) could be a good turnaround play, too. We advised selling the stock in our January 2016 issue, when the stock was trading at $640, because of concerns about a slowdown in sales and weaker profit margins. The company then faced its worst crisis ever: an outbreak of E. coli bacteria that sickened customers and sent sales into a tailspin.

Yet Chipotle remains a preeminent brand in the fast-casual restaurant business. The company has invested heavily in new food safety procedures, and it’s starting to woo back customers with a loyalty rewards program. Analysts expect sales to fall by 10% this year but then rebound by 17%, to $4.7 billion, in 2017. Chipotle also plans to open more than 220 stores by the end of this year, including its new Asian-style Shop House and its first burger joint, called Tasty Made.

The stock looks like a better value. It trades at about three times estimated 2016 sales, well below the five-year average of 4.7 times sales, according to Morningstar. A long-term recovery looks “more likely than not,” says Credit Suisse, which rates the stock a “buy” and sees it hitting $500 over the next 12 months.

For truly intrepid bottom-feeders, Lumber Liquidators Holdings (LL, $15.97) could be a winner. The shares have collapsed from $70 in early 2015, following reports that the company sold toxic, Chinese-made flooring. Liabilities from class-action lawsuits related to the products could cripple the firm.

One investor who isn’t deterred by these issues is Craig Hodges, co-manager of the Hodges Pure Contrarian Fund. As he sees it, Lumber should be able to handle the legal expenses and return to profitability next year. Its products remain popular with builders, he adds, and the firm should benefit from a strong housing market. “The business isn’t bad,” he says. “The management team just messed it up tremendously.” Over the next 18 months, he expects the stock to climb back into the high $20s.