In this article we’ll check out the 10 Best Catalyst-Driven Value Stocks to Buy Now.
After a decade of neglect, value stocks have landed on investors’ radar again in dramatic fashion following the November 9 announcement that Pfizer Inc. (NYSE:PFE) and BioNTech’s Covid-19 vaccine candidate is more than 90% successful at preventing infection by the coronavirus.
According to JPMorgan, that announcement lead to the biggest one-day gains for value stocks (over 6%) alongside the biggest one-day drop in momentum stocks (a slide of nearly 14%) in history. While growth stocks are still the big winners of the pandemic thus far, gaining over 25%, the pandemic finish line materializing a little more resolutely into place has seemingly shaken the market out of the dream-like pandemic grace period it had fallen into, where assumptions about post-pandemic growth could rule the day in lieu of more tangible data.
In a post-pandemic world where bond yields and inflation are likely to accelerate, even greater pressure will be put on growth stocks to meet the lofty expectations investors have placed on them, including living up to a P/E ratio of 38x according to Citigroup, which is approaching perilously close to the dot-com bubble’s peak hubris of a 47x P/E. On the other hand, there is plenty of potential room to run for value stocks, which are still down by over 5% in 2020 and trade at a P/E of just 17x.
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To uncover a list of promising value stocks we turned to Marc Majzner’s Clearline Capital, a catalyst-driven long/short equity hedge fund based in New York which has a focus on mid-cap stocks. The fund applies a value investing approach to its broader strategy, with a focus on cheap, catalyst-driven stocks that display compelling risk/reward profiles of greater than 50% upside and less than 15% downside. Mr. Majzner, who serves as Clearline’s Portfolio Manager, launched the fund in 2012 with $70 million in seed money from Talpion Fund Management and its Founder Henry Swieca after Mr. Majzner’s 17-month stint as Senior Portfolio Manager at Talpion.
Clearline Capital Partners LP is coming off a tremendous 2019 in which the fund returned 60.84%, lifting its compound annual return above 11% through April 2020. That followed a rough stretch during which the fund had negative returns during three of the prior four years and saw its assets under management plummet. Clearline Capital had $381 million in assets under management at the end of June 2020, down from $1.44 billion in September 2016.
Clearline Capital was relatively busy during the September quarter, adding 34 stocks to its portfolio and building larger stakes in 28 of its existing holdings. Of its seven largest positions on September 30, the fund was bullish on all of them during Q3. We’ll take a closer look at those holdings below, as well as three other stocks the fund has been buying up recently.
There’s a very good reason why we pay close attention to hedge fund sentiment before making investment decisions. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, though the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by more than 66 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter. Even if you aren’t comfortable with shorting stocks, you should at least avoid initiating long positions in stocks that are in our short portfolio.
Let’s check out ten of the catalyst-driven value stocks that Clearline Capital expects big things from in the months to come.
10. ACI Worldwide Inc (NASDAQ:ACIW)
Our list kicks off with ACI Worldwide Inc (NASDAQ:ACIW), a payments processor which activist investor Jeffrey Smith of Starboard Value has also taken a keen interest in recently, building a 9% ownership stake in the company and calling it an “attractive” takeover target. Clearline Capital opened a new position in ACIW during Q3 consisting of 203,241 shares.
Smith presented ACI Worldwide at the Capitalize for Kids investors conference in October, noting that the company has massively underperformed its peers over the past five years and trades at a sharp valuation discount to many of them despite a strong collection of assets. In lieu of a full sale, ACI could alternatively look to break itself up, separating its higher growth bill paying unit from its high-margin software business.
9. DXC Technology Co (NYSE:DXC)
Clearline Capital acquired 285,851 shares of DXC Technology Co (NYSE:DXC) during Q3, making a huge addition to the small position in the stock that it had maintained since selling off the vast majority of its DXC holding in Q2. The IT services company was Clearline’s top stock pick between Q3 2019 and Q1 2020.
In its final investor letter of 2019, David Einhorn’s Greenlight Capital detailed some of the initiatives DXC has been undertaking and expressed optimism that the company was on the right track with its new strategic focus:
“After a difficult post-merger period that resulted in substantial lost business, DXC brought on a new CEO with previous experience managing a successful turnaround of a similar operation. Subsequently, the company has announced a new strategy to refocus on DXC’s core business and leverage it with clients. DXC also lowered earnings expectations through 2022. The company has begun the process of divesting ancillary businesses totaling about 25% of revenue, with the proceeds targeted to pay down debt and buy back over one-third of shares outstanding over the next 10 quarters. We believe many of the challenges at the company are self-inflicted and can be fixed. Our field research reveals early signs that improvement is underway, and at our average purchase price of $36.54 (7x the reduced current year consensus earnings) we think little of that is priced in. DXC ended the quarter at $37.59.”
8. American Eagle Outfitters Inc. (NYSE:AEO)
Marc Majzner’s hedge fund took a position in American Eagle Outfitters Inc. (NYSE:AEO) during Q2 and added another 248,954 shares to it in Q3, building a $5.85 million position as of the end of September. Clearline was one of several funds to take stakes in AEO during Q2, as there was a 38% surge in ownership of the stock among the exclusive group of hedge funds that Insider Monkey tracks.
Shares of the retailer have gained 25% in the fourth quarter, but still trade at a discount rack price of about 9x earnings. While sales were still down year-over-year at its flagship locations in Q3, its digital sales posted 29% gains from a year ago, while its Aerie lingerie division delivered a 34% sales boost and could triple sales over the next five years according to Jefferies. AEO suspended its dividend in June and undertook several other initiatives in Q2 in light of the pandemic, which helped the company achieve strong margins in Q3.
7. The Brink’s Company (NYSE:BCO)
Clearline Capital took a stake in The Brink’s Company (NYSE:BCO) during the second quarter of this year, shortly after Brink’s announced that it would acquire storage services company G4Si, as well as the cash operations of G4S in 17 markets. Clearline made another big investment in Brink’s during Q3, buying another 267,429 BCO shares.
The security services company’s shares are still well off their pre-pandemic levels but have gained 68% in Q4. Brink’s has handily beaten estimates in each of the past two quarters and expects revenue to rebound close to 2019 levels next year while delivering what would amount to record adjusted EBITDA of between $615 million and $805 million.
6. Macquarie Infrastructure Corporation (NYSE:MIC)
Hedge fund ownership of Macquarie Infrastructure Corporation (NYSE:MIC) cratered between 2015 and 2017, preceding a massive decline in the stock in early 2018 when the fuel storage company cut its dividend payments in order to focus on tax-incentivized growth projects. It appears some of those investments have been paying off, as hedge funds have been buying back into the stock since the start of 2019.
Clearline Capital was one of those funds, opening a stake in MIC during the fourth quarter of last year, during which the company announced it was pursuing strategic alternatives. In the third quarter, Clealine bought another 143,311 MIC shares, giving it 588,249 overall and a $15.82 million position in the company as of September 30. Earlier this month, Macquarie announced that it will sell its IMTT unit for $2.7 billion and pay out a special dividend of $10.75 per share at some point following the sale’s close.
5. Whole Earth Brands Inc. (NASDAQ:FREE)
Leading off the second half of our list of Mark Majzner’s top catalyst-driven value stock picks is Whole Earth Brands Inc. (NASDAQ:FREE), a packaged foods company that focuses on healthy foods and sugar-free sweeteners. Clearline Capital took a stake in FREE during Q2 and added another 618,514 shares to it in Q3.
Whole Earth, which announced the acquisition of health food brand Swerve for $80 million earlier this month, is chaired by former longtime The Hain Celestial Group, Inc. (NASDAQ:HAIN) CEO Irwin Simon, who took that company from less than $20 million in sales in 1994 to more than $2 billion today.
The company’s valuation looks dirt cheap according to Maran Capital, which discussed Whole Earth Brands in its Q3 investor letter:
“It has dominant market share in France and parts of Europe with its Canderel brand, leading market share in its licorice-based flavorings business, and strong growth brands in its Whole Earth and Pure Via natural non-sugar sweeteners (the former grew 70% y/y in 1H 2020).
These leading brands should generate just under $300mm of revenue, ~$65mm of EBITDA, and over $1/sh of cash earnings next year. Yet, at a market cap of $300mm and an enterprise value of $385mm, FREE is trading at 1.3x sales, 6x EBITDA, and 8x cash earnings. An undemanding set of expectations is embedded in this valuation.”
4. MagnaChip Semiconductor Corporation (NYSE:MX)
Clearline bought just over 151,000 shares of MagnaChip Semiconductor Corporation (NYSE:MX) during Q3, building a position of 1.19 million shares valued at $16.36 million on September 30. Hedge funds have gradually been growing more bullish on the chipmaker, which is in the process of a major transformation that seeks to make it a smaller, more profitable company.
MagnaChip completed the sale of its Foundry Services Group and Fab 4 in September, using the proceeds to strengthen its balance sheet. The company anticipates strong future growth in several areas of its remaining operations as OLED and 5G adoption continue to grow, with plans to achieve a topline CAGR in the double digits and consistent gross profit margins in the 30% range.
3. MicroStrategy Incorporated (NASDAQ:MSTR)
MicroStrategy Incorporated (NASDAQ:MSTR) has been a huge performer for Clearline Capital this year, gaining 88%. The fund first took a position in the data analytics software company back in 2017 and raised the size of its position by another 56% during Q3.
However, it’s not the company’s software, but rather its recent move to push the majority of its cash holdings into bitcoin that has made the company more valuable and piqued investors’ interest. The company’s $425 million Q3 purchase of 38,250 BTC has already made the company hundreds of millions of dollars, with the price of BTC up by over 50% since the company’s investment. A few days ago, short seller Citron Research, which is also long BTC, said MicroStrategy is now the best way to play bitcoin on the stock market, suggesting MSTR shares could hit $700 if BTC hits $50,000 (granted, that’s a somewhat big if).
2. Mednax Inc. (NYSE:MD)
Clearline bought another 440,869 Mednax Inc. (NYSE:MD) shares during Q3, giving it 1.36 million shares worth $22.18 million on September 30. There was a surge in hedge fund ownership of Mednax at the end of 2019 after Jeffrey Smith’s Starboard Value took a stake in the health services company and pushed for a partial or full sale and to remake its board.
The acclaimed activist has been successful on both counts, reaching a settlement with the company in July that included its CEO being removed and several board members replaced. Mednax then announced in September that it would be divesting its radiology business in a deal for $885 million, improving its struggling balance sheet and allowing it to focus on its core businesses.
1. Xperi Holding Corporation (NASDAQ:XPER)
Xperi Holding Corporation (NASDAQ:XPER) is Clearline Capital’s top holding for the second consecutive quarter, with the fund buying another 418,848 shares of the digital technology platform, which completed its merger with TiVo at the beginning of June. Shares of XPER have gained 38% since, largely on the strength of the company’s $202.8 million revenue showing in Q3, a 250% hike from a year ago.
Xperi recently reached a settlement with Comcast Corp (NASDAQ:CMCSA) regarding several disputed patents, removing any doubts about its IP portfolio. There are further catalysts to come, as Xperi plans to split its assets into two separate businesses (IP licensing and products) next year, a move that TiVo was originally planning itself before agreeing to the merger with Xperi instead.
For more great value investing ideas, be sure to check out the Top 10 Stocks Warren Buffett Just Bought.
