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Why the Market Is Broken… in One Stock

by | Dec 8, 2022 | Market Outlook

I love to buy stocks when they’re on sale. If something is worth $0.50 on the dollar and conditions are set to improve, I’m ready to step in and purchase it.

Unfortunately, over the last 14 years, it’s been hard to find a bargain. You typically need to wait for some sort of crisis. But — sure enough — we’ve had five of them in the last decade.

And I’m not even counting the aftermath of the Great Financial Crisis.

Don’t believe me? Check the tape…

  • We had the 2011 U.S. Debt Ceiling and the European Debt crisis.
  • The great Chinese yuan crisis of 2015 nearly sank the global economy.
  • We had a Fed-driven tantrum thanks to rising interest rates and liquidity problems in the bond market in 2018.
  • There was the Great Covid Crash of 2020.
  • And now… we have whatever you want to call 2022. I call it a valuation crisis.

Good companies trading under their liquidation value, operating in sectors that will require their goods and services, are on my radar. However, something quite unusual is happening in 2022, which raises my blood pressure a bit ahead of 2023.

Some of the cheapest value stocks with low liquidity and volumes are actually trading in lockstep with momentum in 2022. And that’s both a warning and an opportunity when we think about liquidity in the markets in 2023.

Momentum Moves and Rebounds

Six major momentum shifts have marked this year.

Momentum-driven selloffs started on January 13, February 12, April 6, June 8, August 15 and December 6.

Momentum-driven rebounds started on January 28, March 16, May 24, July 18 and October 15.

I’ve seen big swings in stocks with high short interest around those dates.

We’ve seen mega-cap stocks like Apple Inc. (Nasdaq: AAPL) and active ETFs like ARK Innovation ETF (NYSE: ARKK) move in lockstep with market momentum. And that’s to be expected.

Momentum is a measurement of capital inflows and outflows in real time. The daily signal shows net inflows started on those rebound dates, while negative signals signal short-term tops.

But I want to show you a stock that should act differently than it has in 2022.

And it should draw your attention to opportunity as momentum bounces in 2023.

The Steel Value Play

I doubt you’ve heard much of a company called Friedman Industries Inc. (NYSE: FRD).

This is a tiny steel parts manufacturer based in Texas. Its market capitalization is just $64 million, placing it in the bottom barrel of the nanocap space. The company produces steel sheets for the shipping container industry. It also makes tubing for the ever-successful oil and gas industry in the Texas basins.

The stock is so tiny that most investors couldn’t find it on a database. And it’s simply too small for hedge funds or private equity companies to own. If a hedge fund is deploying $1 billion in cash, it must file at 10-F and take a board seat with just a $6-million investment. That won’t do.

This stock is so ignored and so illiquid that it currently trades for about $0.60 on the dollar. Its tangible book value — a measurement of its assets on the balance sheet — puts the stock at $13.94.

But imagine that it went under and had to go to auction. Even at $0.75 on the dollar — remember, we’re talking about a steel parts company — the stock would be worth at least $10.45.

Today, it trades at $8.74. That’s a 16% discount from the auction scenario.

So — in that situation — I should just buy the stock and hold it, right?

After all, I’d be getting one heck of a sale.

Well, that’s not been the case in 2022. Look at this chart. 

This little tiny value stock is trading like a momentum stock.

Look at the selloffs. They align perfectly with the momentum dates that I listed above. They came in January, April, June and August.

Now, look at the rebounds. Three times this stock has dropped to about $7 — or about half of its tangible book value. And three times it has rebounded back above $10.

So, if I bought at $7 three times and sold at $10 three times, I’d have more than doubled my money this year. How crazy is that??

I’m adding FRD to my radar as it presents a special situation. In a market of chaotic momentum moves, it’s always wise to look down at the illiquid parts of the market.

If I’m going to buy this stock, I always set a limit order and never purchase at market price. I could quickly distort the buy/sell order flow and pay more than I should.

To your wealth,

Garrett

WRITTEN BY<br>Garrett Baldwin

WRITTEN BY
Garrett Baldwin

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