These three beaten-down stocks have plenty of potential to soar once again, says advisor Gabriel Wisdom, who specializes in searching for turnaround gems. He tells MoneyShow.com about those names, as well as some blue chips he believes are also ready to rally.

Kate Stalter: I am speaking with Gabriel Wisdom of American Money Management. He is also the author of Wisdom on Value Investing: How to Profit on Fallen Angels, and he is the host of the Gabe Wisdom show on the Business Talk Radio Network.

Gabe in addition to the Fallen Angels, you also manage retirement portfolios. So let’s start by talking about that today. What you are putting your clients into in that particular regard?

Gabriel Wisdom: Well, retirement investing is kind of a funny thing, because the psychology for people is different than it is with their after-tax money.

In retirement accounts, they allow for more volatility, and it gives us an opportunity to be buying when we should be…instead of doing what individual investors most commonly do, freak out because of excessive volatility or after sharp declines. They want to sell when they should be buying.

Retirement investing is a different psychology, so it is actually better, and the returns generally are better.

Kate Stalter: How are you advising your clients to be living through the recent volatility in the market? How are you are counseling them, at this time?

Gabriel Wisdom: Well, Kate, volatility…we know it makes people very, very nervous. They associate the big price swings with instability and risk. Yet the fact remains: When stocks or bonds rise and fall day-to-day, it rarely reflects what is happening in the instrument or in the business.

Ron Baron told his shareholders of the Baron Funds recently that market volatility has been made worse by computer-driven high-frequency trading, and based on their research they think that in the short term, excessive volatility has actually lowered stock prices by scaring potential investors away.

Both individual and institutional investors have been scared away, and we think that that makes a lot of sense. We also believe it presents a good deal of opportunity. So we like the volatility; we have been acquiring companies while they are cheap.

Kate Stalter: Tell us about some of the names that you are acquiring for the retirement portfolio.

Gabriel Wisdom: I have to talk about something that we are not contemplating buying or selling. So let me start with Veeco (VECO). They operate in the semiconductor-equipment industry. They are a major supplier of manufacturing equipment to the disk drive, LED, and solar cell markets.

This thing has just been beaten down to a fraction of its former price. It is trading in the very low $20 range. We think there is a 50% upside to our $35 price target over the next 12 months. This is a company that has return on equity of almost 40%, and profit margins over the last year have been 27%.

The shares sold off more than 55% since summer. This is a classic Fallen Angel. This is the sort of thing we look for.

Kate Stalter: Let’s turn then to the Fallen Angels, because that is such an interesting concept. Give us a little bit of background of what that is.

Gabriel Wisdom: A Fallen Angel is a stock or other investment that has fallen but should be rising—not the classic definition of a fallen angel, which used to be a term applied to bonds that had been downgraded.

A Fallen Angel in our world is an angel that has fallen, but it should be flying. There are common characteristics to every great contrarian investment opportunity, and every great Fallen Angel:

  • No. 1, the interest in the asset class or the company has completely petered out. If you think back ten years ago, recall that gold, steel, copper, and energy—these prices were five to ten times lower then and nobody was interested.
  • No. 2, if the topic of this stock or this whole area comes up, it makes your eyes glaze over. Today, you think about Japanese stocks or bank stocks. Bank stocks have been pretty strong here in the first few weeks of the year. Blue chip stocks…for the long run nobody is interested, and prices are falling, but revenues have doubled or tripled over the past ten years.
  • Finally, a declining dollar always buys less and less; it is how the system is rigged, regardless of what politicians say. The contrarian investment that you buy becomes worth more and more. Tomorrow, the compounding of shareholders’ equity at 10% or greater every year gives you twice as much equity or book value in just seven years.

So that’s the three common characteristics of a great fallen angel.

Continued…

|pagebreak|

Kate Stalter: So what are some names that you are looking at in this portfolio, at this time?

Gabriel Wisdom: Well we like the dividend aristocrats—companies that have been paying dividends for many, many years and have raised dividends for at least 20 years, each of the last 20 years.

Many are household names; some are members of the Dow Jones averages. In fact, I happen to like the five most beaten-down stocks in the Dow Jones averages: Bank of America (BAC), JPMorgan (JPM), Alcoa (AA)…

We did some research on the five worst. They have an implied upside of 55%, based on analysts’ targets, the consensus target for the end of 2012. Each one of these five companies pays dividends, and they have shown that they are able and willing to raise dividends. I think Bank of America will begin initiating a dividend—it is certainly turning around.

Kate Stalter: Any smaller caps within this list?

Gabriel Wisdom: There are always small-cap names that we get interested in. In my book, the last chapter, “10 Fallen Angels for the Next Five Years.” Anybody that is interested in looking at that list and tearing apart those names can go to wisdomonvalueinvesting.com, or just enter “Wisdom on Value Investing” and you will see the link to it.

The annualized rates of return on the ten Fallen Angels for the next five years, since the book came out, is very, very high. Not to get anybody too excited, because we know that past performance is totally meaningless, but some of the names on the small-cap side that showed up for me are:

Move (MOVE). This is a real-estate service provider down more than 90% from its old highs; you may know it by the more common Web site, realtor.com. I don’t think there is a realtor in America that doesn’t use their service on a daily basis, and Move is really beaten down. They just did a reverse split and that made things even worse…but fundamentally things are getting better.

I like Skechers (SKX). They make shoes. The stock has been down more than 75% from the old highs; it looks real good to me.

World Fuel Services (INT). That is a fuel services provider that has been hammered and doesn’t deserve to be. There are lots of great opportunities right now because of what Ron Baron is saying about the volatility scaring away investors. It has caused stocks to be cheaper, especially the small caps.