The S&P 500 will remain range bound until it breaks out of 2500 or breaks down below 2400 levels. Therefore, we have to be more stock specific in our approach because a few stocks will continue to rally while the index consolidates. As the index lacks momentum, this week, we have chosen a few stocks that are possible turnaround candidates.
- The S&P 500 is range bound, however, individual stocks are likely to outperform
- We have adopted a bottom-up investing approach in this article
- We believe GPRO and AEO are turnaround candidates
Though risky, such stocks can offer huge returns if our analysis proves to be correct. However, if the company fails to perform according to our expectations, stocks can fall lower. Therefore, you should always strictly adhere to the recommended stop loss. Also, once the stock moves in your favor, please keep trailing the stops higher.
As long as the S&P 500 remains above 2400, we shall continue to look for buying opportunities. We shall become negative on the markets only if the index breaks below 2400 levels. We have identified two stocks that are showing signs of a turnaround, both fundamentally and technically.
Let’s analyze the stocks.
GoPro – (NASDAQ: GPRO), Buy at the current levels, SL 8, Target 15 and 18
GoPro is an action camera manufacturer founded in 2002. The stock has been languishing near its lows due to its weak performance in the past few quarters.
However, the recent results and guidance shows that the company is on a turnaround path. It has recorded higher revenues and better margins in the second quarter of this year and has forecast that it will meet the higher end of its guidance for the third quarter. This shows that demand for their products is increasing.
It has a few top end products lined up for launch, which are likely to boost both the bottom line and the top line of the company. This has rekindled hopes that the company will be able to turn profitable if the new launches are successful. This hope is pushing the stock prices higher.
Additionally, the upgrades by Goldman Sachs from Sell to Neutral, and by Morgan Stanley from underweight to equal weight has also boosted prices. However, a lot hinges on the new product launches. If these fail to generate interest among consumers, the turnaround story will fall flat on its face. Nevertheless, if the products are a success and the company turns profitable, the stock is likely to be re-rated and the investors can reap huge rewards.
The long-term chart of GPRO looks scary. It has lost about 90% from its highs of $98.47 in October 2014. The stock had fallen to $7.15 levels in March of this year. Since then, the stock is on the mend and is showing signs of bottoming out.
A breakout above $11.1 will start a new uptrend in the stock, which should can take the stock to $15 levels.
The daily chart shows a base formation, with the stock taking support at $7.5 levels. It has formed an inverse head and shoulders bottom, which will complete on a breakout above $11.1. On August 4, the stock had gapped up sharply, however, it could not breakout of the overhead resistance. Selling close to the $11.1 levels pushed the stock back down to about $8.5 levels. However, the stock has again gapped up on September 7 and is again attempting to breakout above the neckline.
We recommend entering 50% of the allocation size at the current levels, keeping a stop loss of $8. The remaining 50% allocation can be purchased when the stock breaks out of $11.1. The minimum pattern target is $15, though the stock can surprise on the upside and even reach $18 levels. Therefore, the risk to reward ratio is favorable.
American Eagle Outfitters, Inc. – (NYSE: AEO), Buy at the current levels, SL 9, Target 19
The retail sector in the US is going through a disruptive phase, due to changes in consumer behavior and the growth in online shopping. This has led to a sharp fall in the margins and growth of the brick and mortar retailers. As a result, the whole sector has been punished, plunging stocks to multi-year lows.
However, we believe that a few stocks in the retail sector are showing signs of a turnaround. These companies are adapting to the changing consumer needs and are likely to emerge stronger. One such company is AEO, owner of the American Eagle Outfitters® and Aerie® brands.
The company has maintained positive comparable sales growth for ten straight quarters. This shows that the company’s products are able to withstand the cut-throat competition.
However, the increase in sales has not resulted in higher net profit, because the margins have taken a hit, due to promotional offers.
Nonetheless, AEO has increased its online sales, which now accounts for about 23% of the company’s business. This shows that the company is flexible and can quickly adapt to changing consumer requirements.
Also, the low debt to equity ratio provides opportunities to the management to buyout other struggling retail companies. Presently, AEO has a very limited international exposure, which it plans to expand. This will help diversify its business. With these positives in mind, we want to build a position in the stock before it gets re-rated.
AEO has remained range bound between $10 to $20 for almost seven years. During this period, the stock has fallen to the $10 levels thrice. All these three occasions proved to be a good buying opportunity because every time the stock rallied back to at least $18 levels. This time too, as the company improves its performance, we expect the same trend to play out. We have a clear stop loss at $9, a level that has not been touched since 2009 and our target objective is $19. This gives us a good risk to reward ratio.
On the daily chart, we find that the stock has broken out of the downtrend line and has moved above both the 20-day exponential moving average (EMA) and the 50-day simple moving average (SMA). This shows that the stock is finding buyers at the $10 levels. Therefore, we can buy the stock in a phased manner, purchasing about 50% of the total allocation at the current levels and buying the rest on dips to $10.5 levels. The stop loss for the trade should be a close below $9 level. On the upside, the stock is likely to rally to $14.5, once it breaks out of $13. Thereafter, it has a small resistance at $16 after which it is likely to rally to $19 levels.