Start Small, Win Big With Diamond Foods
Oct 2nd 2012 4:32PM
Updated Oct 2nd 2012 4:36PM
Wall Street pros have nothing on retail investors who stake small sums of money monthly on undervalued small-cap stocks. Because they're mostly ignored by the big guns, these types of stocks offer the best outsize opportunities for growth.
I screened for stocks under $3 billion in market cap, offering earnings surprises of 15% or more in the previous quarter, with long-term earnings growth forecast to be at least 15%. I then filtered the findings through the collective investing wisdom of the Motley Fool CAPS community, looking at those they think have the best chance for winning.
One stock that floated to the top was walnut farmer Diamond Foods (Nasdaq: DMND ) , which saw earnings jump 18% ahead of analyst expectations. Wall Street still expects its earnings to grow 15% annually for the next five years, and with a $410 million market cap, it falls squarely into our range for potential investment candidates.
Of course, don't jump on a stock just for those reasons. It should just be a starting point for more research as we need to look more closely to see whether analysts' faith in it is well-founded.
Of course the big caveat here is that Diamond hasn't filed any financial statements in over a year. The Nasdaq stock exchange says that if the nut grower doesn't get current in its filings by the end of the year -- and that would be its annual report for 2011 along with the first three quarters of 2012 -- it's going to be delisted from the exchange.
As is well known, Diamond was put through a grinder when it was revealed that the company made $50 million in "momentum" payments to walnut growers last year that were actually for walnuts purchased the year before and thus improper. In addition to restating two years' worth of financials, it fired its CEO and CFO because of their role in artificially boosting earnings. Had those payments been included in Diamond's financial statements then, operating profits would have been halved.
Worse, though, was the impact it had on its planned acquisition of the Pringles business from Procter & Gamble (NYSE: PG ) . Instead of becoming the second-biggest snack foods company behind PepsiCo's (NYSE: PEP ) Frito Lay division, it had to watch the deal unravel and suffer the torment of Kellogg (NYSE: K ) stepping in and snapping up the brand, which served to triple the size of its snack division.
Stock exchanges are pretty lenient in letting companies get their financial houses back in order, so the Nasdaq says Diamond has until Dec. 7 to file all those forms and then has until mid-January 2013 to hold its annual meeting. I'm wondering, though, whether this is D-Day for the nut grower too. In its press release announcing the extension, Diamond doesn't say it will meet those dates, but rather will do so "as promptly as practical." This may be one and the same, but then again, maybe it's not.
A short story
Although Diamond shares sold short are down from their peak, 45% of its float is still sold short and the days to cover remains at extremely high levels of 24 days, though that also means any bit of good news could send its stock soaring amid a short squeeze.
The shorts may be sitting on the wrong side of this one, as noted hedge fund operator David Einhorn pointed out in closing out his own short position on the nut grower. Diamond moved swiftly in ferreting out the wrongdoing, and actually found and corrected the problem. Such "self-policing happens too infrequently and we think it deserves to be noticed and applauded," said Einhorn.
Certainly there doesn't seem to be much further down it can go, having lost three-quarters of its value since the accounting scandal broke (yes, all the way to zero is always possible). Yet it's doubtful it can regain those former highs, too. Much of the gains were based upon it acquiring the Pringles brand, and with that catalyst removed from the equation, what's left to propel it higher again?
A late-night snack
The restatement will certainly give it a bounce, but that's about all. The popcorn and potato chip business keeps it butting up against rivals PG, Mondelez -- the former Kraft snacks brand that was just spun off its grocery business (which kept the Kraft name) -- and General Mills (NYSE: GIS ) . Yet with the trend toward health and wellness in snack foods, Diamond's best hope lies in being a takeover target itself, at least after the legal liability has been resolved.
That's why I see the nut grower as mostly dead money for the balance of this year, but you can tell me in the comments section below whether you think I'm nuts for not wanting to get in on Diamond Foods at this price.
A small price to pay
Diamond Foods isn't exactly a blazing consumer-facing growth stock, the sort of stock that legendary investor Peter Lynch used to single out before his peers caught on. But a new Motley Fool report singles out three millionaire-maker stocks in that mold, and the free report could open up a few opportunities for you to consider. Click here to check it out now.