Bottom fishing in beaten-down equities is a popular strategy. The lower a stock goes, the greater its value may seem. A big decline can be especially appealing when it occurs in well-known, brand-name stocks.
I caution you on this approach, though. Relative strength (RS) studies have shown that underperforming stocks tend to remain underperformers. A stock's RS can range from 0 to 100, and the lower the number, the worse its performance relative to its peers over the past six months. I have warned of the dangers of investing in stocks with low RS in the past.
Trends tend to persist, and trying to guess when and where a downtrend will stop can wind up being very costly. No doubt you've all heard the phrase, "Never try to catch a falling knife."
Personally, I like to keep emotion out of my investing decisions. That is why I rely on a stock-ranking system that combines an equity's relative strength and a key fundamental metric to give it a score ranging from 0 to 200. I call it the Alpha Score.
Stocks with the highest Alpha Scores have gone on to deliver returns of 115% in six months, 135% in 10 months and 242% in a year. But the flip side is just as important. The Alpha Score keeps me out of stocks that are lagging the market -- no matter how enticing they may look at beaten-down levels.
Below are four brand-name stocks flashing some of the lowest Alpha Scores in the market right now. They may seem like they offer good value, but the technical damage on their charts suggests there's more pain ahead for shareholders.
Stock to Avoid #1: Weight Watchers (NYSE: WTW)
Alpha Score: 34
Weight Watchers has been helping people around the world shed pounds since the 1960s. However, the growing popularity of wearable fitness devices and free weight management apps is hurting the company, whose cheapest option costs $19.95 a month.
Shares collapsed 35% in a single day in late February when management lowered their earnings forecast. In the past six months, shares are down 74%.
The company must find an innovative way to combat new technologies that are eating into its subscriptions and revenue. Until that happens, its Alpha Score of just 34 out of a possible 200 is telling us WTW's upside appears severely limited outside of a reflexive, short-term bounce.
Stock to Avoid #2: Abercrombie & Fitch (NYSE: ANF)
Alpha Score: 25
This once popular teen and young adult retailer has fallen out of favor. Former CEO Mike Jeffries was known for his public relations debacles. Among his many gaffes was a comment that Abercrombie only wanted to sell to "cool people."
Well, the only thing that's cool about Abercrombie appears to be consumers' frosty response to its merchandise. Sales fell 14% in the fourth quarter and the company plans to close 60 U.S. stores in 2015.
ANF is down 41% in the past six months, and its Alpha Score of 25 -- the lowest of all the stocks I'm discussing today -- suggests it has further to fall. The head-and-shoulders top on its chart projects a downside target of $10.73, which is more than 50% below current prices and would undercut the stock's major 2008 low.
Stock to Avoid #3: Caesars Entertainment (NASDAQ: CZR)
Alpha Score: 28
Casino stocks across the board have been struggling due to lower revenues from Macau. However, an analyst from Brean Capital recently said it was time to buy because the Asian gambling mecca is in the process of bottoming.
That may be so, but I wouldn't touch CZR -- or its Alpha Score of 28 -- with a 10-foot pole. While the company's lavish hotels and casinos are well known, it is struggling with the bankruptcy of its operations arm, which carried $18 billion in debt. The judge hearing the case recently appointed an examiner to investigate the transfers and any conflicts of interest between the hundreds of legal entities Caesars created. This is an ominous sign for the company and the stock.
CZR has been entrenched in a downtrend for the past year and is down 27% in the past six months alone. Shares are nearing intermediate support at their October low at $8.51. A break below this level could lead to a test of the all-time lows below $5.
Stock to Avoid #4: Tesla Motors (NASDAQ: TSLA)
Alpha Score: 34
Shares of the electric car manufacturer soared roughly 750% between March 2013 and September 2014, vaulting TSLA to cult stock status.
But shares have fallen out of favor in the past six months, down 25%. Earnings have been on the decline and investors are concerned about increasing future competition, especially in lower-cost car models.
With an Alpha Score of 34, I'm not expecting a turnaround anytime soon. This month, TSLA broke a key support line dating back to May. Technical Analysis 101 tells us that what was support now becomes resistance. Indeed, TSLA has already made one failed attempt to regain this line, and its downtrend remains in force. The next support is near $145.72, more than 20% below current prices.
I'm not in the business of buying underperforming stocks. Sure, I may miss a few bargains, but I'd rather have the peace of mind of knowing that I'm only investing in the absolute strongest stocks in the market.
In 2015 alone, some of the stocks with the highest Alpha Scores have gone on to soar 27%, 29%, 34%, 43% and 54%. And, again, that is just this year. I'll take those returns over trying to catch a falling knife any day.
If you'd like more information about how you can use the Alpha Score to avoid underperformers and invest in stocks ready to make huge runs, I've put together a free presentation.
This article was originally published on ProfitableTrading.com: Warning: Do Not Go Bottom Fishing in These Brand-Name Stocks