Profit from the $5 Threshold With These Two Stocks

Never judge a stock by its share price.

Just because a stock trades for $5 does not make it “cheap.” Conversely, a stock that trades for $100 is not necessarily “expensive.” Millions of investors ignore this. Mention a stock and the first question out of most investors’ mouths is “How much does it cost?”

Consider Berkshire Hathaway (NYSE: BRK-B). The ‘B’ shares of Warren Buffet’s holding company trade for about $3,300. That’s a tidy sum, but it’s a song for what investors are getting: The most successful investor in the world managing their money. Berkshire has a high share price, but it’s easily one of the best values on Wall Street today.

#-ad_banner-#Not only is share price a poor indicator of actual value, it’s also not a good predictor of an investment’s risk.

Wall Street considers any shares trading for less than $5 a penny stock. While some of these securities may well be speculative, illiquid companies that trade over-the-counter or on the Pink Sheets, many others are well known, reputable companies that have simply hit a rough patch and seen their share price slide.

If the price drops too far, it can create some headaches, especially for institutional investors like mutual funds and pensions. These mega-investors, which typical oversee billions of dollars in assets, must follow certain rules that are designed to mitigate risk. Many are often barred from buying any “penny” stock that trades for less than $5. In some cases institutions may even be compelled to sell securities whose stocks fall below the $5 threshold. This can flood the market with shares and drive the price down further.

But the opposite effect also can occur, and that’s today’s opportunity.

When a security that had been trading at below the $5 threshold rises back above it, institutions — and even some individual investors — tend to pile back in.

Here are two stocks within striking distance of $5:

Company (Ticker) Business P/E TTM EPS YTD Return
Smith & Wesson (NASDAQ: SWHC) Gun Maker 6.4 $0.63 +78%
Liz Claiborne (NYSE: LIZ) Retail N/A -$1.31 +80%

Apparel maker Liz Claiborne (NYSE: LIZ) and gun maker Smith & Wesson (Nasdaq: SWHC) were beaten down during the market’s slump, but both are making strong comebacks. These two well-known brands should reach the $5 mark soon and could both see a further bump once that happens.

Liz Claiborne
Liz Claiborne was left for dead in March. The low capped a two-year decline that saw the stock nosedive from about $45 to as low as $1.61 a share. Liz had racked up expenses for years, and when the untimely combination of declining sales and the credit crunch hit, the company went into crisis mode.

To make matters all the worse, it was clear the Liz Claiborne brand — the company owns several others — had lost a step. Management rolled up its sleeves to remake the flagship brand, hiring a marquee designer to reinvent the label and retarget professional women, the brand’s bread-and-butter clientele. As the Liz Claiborne brand is retooled, the company is counting on results from younger customers attracted to higher-end fashions from Lucky Brand Jeans, Juicy Couture and Kate Spade.

Investing in Liz Claiborne is a turnaround bet. Retail is a cutthroat business, but comebacks are possible. LIZ trades at about $4.50 but shares could easily reach $10 or more if the ship is righted by the end of 2010, as management predicts.

On a side note, it was almost one year ago to this day that my colleague Andy Obermueller dedicated an entire Investor Update issue to Liz Claiborne’s rebound. He predicted that several “profit catalysts” would propel the stock to triple-digit gains. The catalysts are working: as I write this, LIZ is up +80% in 2009 — tripling the S&P 500 (another Andy prediction). Visit this link to see which catalyst-driven stocks we predict to surge in 2010. Smith & Wesson
Shares of Smith & Wesson have been on a skid since the company reported that future sales growth was likely to decline.

Guns have flown off the shelves since President Barack Obama and other Democrats won control of Capitol Hill last November. Gun owners, fearing that Democrats typically support gun control, proceeded to stock up before any such laws were tightened.

The run on guns may be ending, but Smith & Wesson is still worth considering. The company expects sales growth between +8% and +14% in the fiscal third quarter — a far cry from the +49% jump in the previous quarter, but enviable nonetheless.

The value of the Smith & Wesson brand alone makes the company intriguing. Horace Smith and D.B. Wesson first began making revolvers in 1852. The popular .38 Special ammunition has been used by nearly every law enforcement agency in the world at some point. The Model 10 handgun has been in continuous production since 1899, with more than six million units made.

Smith & Wesson trades for seven times earnings, compared with a two-year average of more than 20 — implying an upside of +185%. If Congress even remotely considers gun control, shares are likely to return to a similar valuation.