How Breakout Stocks can Transform your Portfolio

By Hilary Kramer

Breakout stocks can come in all kinds of shapes and sizes, but the ones on my buy list all share three things: 1) They are low-priced (mainly under $5); 2) undervalued; and 3) have specific catalysts in the near future that put them on the threshold of breaking out to much higher prices. When they do, the snowball effect kicks in as institutions climb on board and drive the price even higher. That’s when we make a lot of money – potentially a whole lot of money.

Investing in undervalued stocks can be risky if you don’t know what you’re doing. After all, some stocks get beaten down for good reason. The key, of course, is to figure out if a stock is truly a breakout stock or merely a broken stock.

Big Breakout Winners

As I mentioned, breakout stocks come in many shapes and sizes, but I’ve enjoyed some of my biggest profits investing in stocks that fell into two categories: a little-known company with a great new product, or a company that has fallen on hard times but is righting the ship.

Dendreon (DNDN), for example, was on Wall Street’s garbage heap (where I’ve found more than one opportunity) because it had burned money managers once before. The company makes a potentially revolutionary new cancer treatment – a vaccine made from the patient’s own immune cells. The company was confident it would receive FDA approval for its drug, but that approval was unexpectedly denied in 2007. Wall Street, feeling spurned, dumped the stock and walked away. DNDN plummeted from $19.40 to just over $2.60 by May 2009.

That’s when I got interested. After extensive research and checking with my contacts who really understood the drug’s revolutionary potential and likely approval in the future, I jumped in and bought. Less than a year later, in April 2010, Dendreon did indeed receive full approval, and the stock more than doubled in a mere four months. As for me, I had a ten-bagger on my hands. I purchased the stock on March 12, 2009 at $3.42 and locked in those gains on April 30, 2010 at $54.43 for a profit of 1,491%!

The other big category of breakout stocks is those that have been beaten down but are spring-loaded and ready to pop back up. Stocks often take a pounding when a company takes its eye off the ball, becomes too unruly to control, grows recklessly or strays from its core competency.

Many of them are permanently damaged and should be avoided. But certain companies have what it takes to climb out of the deep abyss – innovation, fortitude, skilled management – and those are the stocks that can break out.

Citigroup (C) is a perfect example of a once great highflyer that fell on extremely hard times. What had once been one of the premier global banks, known for its quality management and strict risk controls, found itself transformed into a mediocre financial supermarket – which was then in the eye of a historically severe credit crisis.

As we know, this was disastrous for Citi. Eventually, the stock dove from $55 down under $1! It may have been overvalued at $55, but I knew there was no way it was a $1 stock. The government wouldn’t and couldn’t let Citi fail, and there were still very strong and lucrative areas of the bank to drive profitability in the future. I bought the stock on February 23, 2009, for $1.49, and sold on August 24, 2009, at $5.23, a nice 251% return in just two months.

I have found similarly great opportunities when an entire sector is left for dead by identifying the best companies and riding them up. These might be broken stocks but not broken companies, and that disconnect won’t last. My favorite example here is Priceline.com (PCLN).

When the tech bubble burst, it took down a lot of garbage that deserved to be thrown away, like Pets.com. However, there were a handful of legitimate businesses with phenomenal potential that were also taken out to the woodshed just because they were dot.com companies. Priceline went from $279 on June 2, 2000, to under $8 by the end of the year. Ouch!

The stock was left for dead, but I knew Priceline was a solid company with an innovative business model that could actually work. While on the road analyzing companies, I would notice that Priceline was becoming a standard and acceptable means of booking travel at a discount. Wall Street missed the boat, but then again, much of Wall Street was out of touch about online travel.

I knew online booking wasn’t going to disappear and, eventually, the market would consolidate around a winner. I bought PCLN on February 3, 2003, at $7.50 per share. I have sold some of my shares over the years to lock in profits, but I still have a position in the stock and have enjoyed an upward run of more than 2,000%.

So, What’s a Breakout Stock?

When I’m looking for a true breakout stock under $5, I need to see the potential for at least 50% upside and preferably more. I would say 50% to 200% in the coming six to 24 months is a good general expectation, but some will certainly move higher and faster than others.

Finding these stocks takes hours of research, investigation and analysis, and to be honest with you, I love it. I get to be a detective, a business scholar, an investment analyst, a trader and a secretive hedge fund manager. I talk to people in the field, travel around the globe to see a company’s operations and outthink the herd mentality on Wall Street that seduces you into buying high and selling low.

That’s especially true when it comes to low-priced stocks. Here’s the catch: As a stock’s price falls, the downward spiral becomes a self-fulfilling prophecy because Wall Street’s analysts won’t cover low-priced stocks. Then, to make matters even worse, nearly all large institutions shy away from buying stocks under $10 and certainly under $5.

This is where opportunity and danger meet, and it’s why for any stock to pass muster, I must have immense conviction that the company has what it takes to dig itself up and out of the "under $5" category. And when it does, that’s when the excitement really kicks in. Then, anupward spiral becomes a self-fulfilling prophecy as institutions start to both cover the stock and invest in it, which accelerates the breakout.

I hope that gives you a sense of the kinds of opportunities breakout stocks have to offer. The pickins’ are rich right now, so let’s get right to the stocks I want you to start with.

3 Breakout Stocks to Buy Now

If I asked you to pick THE one sector that has been beaten down the worst, what would be the first answer to come to mind? I suspect most of you would say "financials," and you would be right. After all, the whole system darned near collapsed. We’ve come a long way since the days of Bear Stearns and Lehman Brothers disappearing, but the landscape of the entire industry has been forever changed, and the dust is still settling two years later.

Some of the best opportunities out there are buried in this dust, including the first stock I want you to buy now.

Breakout Stock #1:

Cowen: A New and Improved Seasoned Veteran

Cowen Group(COWN) is an investment bank that has actually been around over 90 years, so it is a real veteran of up and down cycles – and it has strong upside potential coming out of the recent down cycle.

I’ve recorded a special video to tell you more about why I think this stock is such a good opportunity, Let me also summarize for you the reasons to own COWN now:

·         The business is a natural beneficiary of the economic turnaround, which is leading to more institutional trading, corporate debt and equity issuance, and M&A activity.

·         Strong markets also mean higher asset prices, which translate into higher fees. Cowen’s Ramius funds earn significant money for COWN’s bottom line by taking a percentage of assets under management, as well as performance fees.

·         Cowen has an impressive balance sheet, with cash and equivalents accounting for a significant part of total assets. This is not a Lehman Brothers or Bear Stearns saddled with overvalued liquid assets!

·         The stock is clearly undervalued and is trading at only around 85% of book value because of all that has happened in the financial sector.

·         One intangible I always look for is management, and Cowen has real strength here. The firm is led by veteran banker Peter Cohen (former CEO of Shearson), who has a reputation as a real dealmaker, a huge asset in the relationship-driven world of investment banking.

·         If another economic downturn should hit, Cowen is well-positioned with long-term minded clients and top bankers that know how to weather any storm on Wall Street.

I recommend you buy COWN under $5 for a target of $10

Breakout Stock #2

Zale: Setting Up for Sparkling Returns

You’re probably familiar with Zale Corporation (ZLC). It’s the second-largest jewelry chain in the U.S. with 1,900 stores throughout the United States, Canada and Puerto Rico, as well as online. Its various brands are also well known: Zales Jewelers, Zales Outlet, Gordon's Jewelers, Peoples Jewellers, Mappins Jewellers and Piercing Pagoda.

My Breakout Stocks Under $5 readers got into the stock last November, just in time to profit from the holiday shopping season. We’re up a “sparkling” 50% so far, but I think the stock could double from current prices. I think this is a great time to buy ZLC, not just because consumers spent more last shopping season, but for many more significant and sustainable reasons.

Now, if you’d asked me about Zale a couple of years ago, I would have told you to stay as far away from the stock as possible. In fact, I shorted it at one point because its very survival was in question. The company came perilously close to going under during the worst of the credit crisis as people quit spending money on jewelry.

On March 9, 2009, the same day that the S&P 500 hit its intraday low of 666, ZLC closed at $0.92. Six months earlier, in the days preceding Lehman Brothers’ bankruptcy, it was trading at more than $30 a share.

Broken or Breakout?

That’s always the question, and in this case, it’s a little bit of both. Zale is one of those companies that stumbled but is righting the ship. I’m convinced Zale would have gone bankrupt in early 2009 if it weren’t for a few seasoned investors who believed this industry leader was worth saving and pumped money into the company.

Breeden Capital, run by former SEC chairman Richard Breeden, amassed a 25% stake in Zale. And John Keeley of Keeley Asset management, a boutique value manager, raised his investment in Zale to the point where it became the second-biggest holding in his Keeley Small Cap Value Fund.

Then, a couple of events last year sealed the change in direction: Golden Gate Capital agreed to lend the company $150 million, which helped alleviate a cash crunch that was so severe Zale couldn’t pay its vendors on time the Christmas before. And then the company shored up a fresh deal for a $650 million credit line led by Bank of America along with a deal for a Canadian store-brand credit card financed by TD Financing Services.

Potential Doubler

Zale was too close to the brink to make it a smart investment at its bottom, but the tides are turning, and I see this stock a potential doubler for a couple of reasons:

First, the improved economy and consumer confidence gave the company a huge boost over the recent holiday shopping season that execs are looking to build on. ZLC jumped 40% – in one day! – after reporting that same-store sales increased 8.5% in the combined November/December period.

These numbers were dramatically different from the year before when sales fell 12%. CEO Theo Killon has attributed the strong sales increases to investments in their field teams, a clear marketing strategy and back-to-basics merchandising. He’s even talked about “a return to profitability,” which would definitely get the attention of investors.

The other big catalyst would be the possible sale of Piercing Pagoda, Zale’s kiosk chain. This has been part of the buzz on this stock. A prominent private equity firm, Apollo Group, was rumored to be interested, but a recent media report cited sources saying the deal was off – at least temporarily. Nothing has been confirmed, but Zale and Apollo have been in on-and-off talks for a while, so I wouldn’t be at all surprised if talks resume at some point. Even rumors of talks would likely boost the stock. Given Zale’s $573 million enterprise value, proceeds from the sale, estimated to be $100 million to $150 million, would be significant for the company.

Investors are noticing the company’s turnaround, but there’s still time to get on board. ZLC hit its 2010 low of $1.35 in early July and actually got close to $6 in early January – a 300%+ run. It has since pulled back under $5, where I think it’s a great buy. A return to profitability could be around the corner, and investors are viewing the company in a different light. Instead of sitting on death’s doorstep, the patient is now sitting up in bed, eating solid foods and growing stronger. A clean bill of health could easily lead to a double from here.

Breakout Stock #3

Fast-Track FDA Approval = Fast Profits

In Breakout Stocks Under $5, we set our sights on lower-priced stocks that are poised to break out to much higher prices. Sometimes we have to wait a little longer while a trend plays out; other times there is a specific event around the corner that is likely to make a stock pop. I spend my days in search of these companies.

There is such a stock on our current buy list that does indeed have a specific catalyst in the not-too-distant future that I expect will drive the stock higher: a date with the FDA for a potential new drug.

Milestones in a drug’s development cycle can send a small, little-known biotech company’s stock soaring. We talked earlier about Dendreon (DNDN). There was actually a day – yes, a DAY – in which it rocketed 200% on successful Phase 3 trials. Investors also pocketed 155% in ONE day when the FDA approved Orexigen Therapeutics’ obesity drug.

Timing is everything when buying biotechs, and the months right before a new drug wins FDA approval can be a major profit opportunity. That’s the case with the third breakout stock I want to tell you about in this report. It is on the cusp of winning that coveted approval.

In fact, the FDA just recently accepted the company’s application for the drug’s approval. Also important, the agency agreed to a six-month Priority Review and set a date of May 30 as the goal by which a decision will be given.

Why the urgency? Because this potential new drug treats the #1 infection acquired by patients in hospitals, and it is a very, very dangerous infection. Also prevalent in nursing homes and hospital nurseries, it affects 3 million people and kills up to 30,000 each year.

It’s difficult to cure and easy to spread. And there is growing alarm over signs of drug resistance and increasingly virulent strains that are causing higher numbers of deaths.

Data from the late-stage clinical trials were very positive. This new drug is proving to be superior in curing and reducing the high recurrence rate by 50% more than competitive drugs already on the market.

The fast-track status is something the FDA only gives to potential new drugs that address life-threatening conditions and have shown potential to address unmet needs.

You MUST get on board now BEFORE the drug is approved in the next few months! 

Breakout Stocks = Opportunity

I have spent most of my life uncovering and investing in these kinds of stocks – starting back in high school when I began to invest and for the last 25 years as a professional money manager. I can tell you from firsthand experience that lower-priced stocks are a great way to build your wealth quickly.

It’s simply easier for a $5 stock to go to $10 than a $50 stock to go to $100. And if that $50 stock does make it to $100, it will likely take a whole lot longer.

I know heightened volatility in the market may have you a little concerned, and that’s understandable. Lower-priced stocks in particular are more volatile by nature. A 50-cent move on a $5 stock is a lot different from a 50-cent move on a $20, $30 or $50 stock. That’s why buy limits are so important in these stocks. I put a lot of thought and analysis into identifying good entry points, and I urge you to adhere to the prices I recommend.

Of course, the flipside of this is what gives us our opportunity. Lower-priced stocks don’t have to move as much on a price basis to generate a big percentage gain.

Breakout Stocks Deliver Standout Profits

·         Hovnanian Enterprises +125%
in 2 months

·         Crocs, Inc +363% in 6 months

·         Developers Diversified Realty Corp. +253 % in 6 months

·         Cabela’s Incorporated +192% in just under a year

·         Industrial Services of America +480% in 13 months

Breakout Brief: Zale Corporation (ZLC) 
Buy Under: $5 
Target Price: $6.50 
Breakout Factors:
• Improving consumer confidence will drive sales higher 
• CEO Theo Killon talking about “a return to profitability”
• Possible sale of Piercing Pagoda chain could boost the stock

Breakout Brief: Cowen Group (COWN)
Buy Under: $5
Target Price: $10.00
Breakout Factors:

• Key business units are strengthening

• Legendary CEO with a great reputation

• Potential takeover candidate at a substantial premium

One Person’s Trash Is Another’s Treasure

70% profits from a scrap metal recycler that has already started to break out… with more to come. It’s rare to find one company that has so many triggers for immediate growth…

·         Exploding demand from China and emerging markets. Massive infrastructure build-out and rising standard of living mean big demand for cars, appliances, steel for buildings and bridges, etc. And in large part because of that…

·         Growth has TRIPLED in the domestic steel industry—this company’s #1 customer.

·         The biggest breakthrough technology the steel industry has seen in decades—electric arc furnace (EAF) technology, which uses scrap metal to make steel. EAF use has already jumped 25% and is set to explode thanks to the lower costs and faster production it offers.

·         Pricing power—the price of ferrous scrap metal (our company’s bread and butter) is up 225% and shows no signs of stopping on growing demand and limited supply.

It’s the perfect takeover candidate. The company will likely put itself up for sale and be snatched up by a mega-cap