Baron Rothschild, a member of the powerful 18th century banking dynasty, is credited with coining the phrase, "Buy when there's blood in the streets." Rothschild recognized that the smartest purchases are often when things appear so dire that nearly all hope has been lost.
This idea is at the heart of contrarian investing. A contrarian is an investor who goes against the herd. They often buy beaten-down stocks in hopes that a positive catalyst will soon drive the price higher. They know that the most value and potential profits come from shares that have been beaten down.
Obviously, being a contrarian does not mean buying stocks that are plunging due to solid fundamental reasons with little hope of recovering. Successful contrarians only invest in beaten-down companies that careful research indicates are about to turn around.
I am a contrarian at heart, but I wait for a beaten-down stock to stop falling and start to bounce before I jump on board. This helps prevent me from "trying to catch a falling knife."
One company that I think is an ideal contrarian play right now is Echo Therapeutics (ECTE).
Beaten-down is an understatement when it comes to this medical device company. The stock was trading near $50 just two and a half short years ago. Shares have plunged over 95% since then to a low below $2.
Echo specializes in medical devices that replace needle injections with transdermal technology. Its Prelude Skin Prep System enables needle-free drug delivery, and its Symphony tCGM System is a wireless and transdermal continuous glucose monitoring system for diabetic patients.
Echo has been losing money for years and just launched another public offering that raised around $11 million in June, further diluting the share price.
So, after two years of atrocious performance, how can this company possibly improve? There are two primary catalysts:
1. There has been a management shakeup.
In late August, it was announced that the company's CEO, Dr. Patrick Mooney, would step down immediately and a member of the company's board would take his place as interim CEO. Changes in critical management positions can often help a company turn around.
2. Activism by major shareholder.
In early September, Echo's largest shareholder, Platinum-Montaur Life Sciences, which owns about 20% of the outstanding common stock, sent a letter outlining a proposal to help turn the company around.
Platinum said it strongly believes Echo has potentially transformative technology that needs to be developed as soon as possible.
The suggestions included restructuring the board of directors to include more experienced medical device executives, hiring a consulting firm to develop a strategic vision, hiring a permanent CEO, teaming with an offshore partner, and offering financing at a premium to prevent the additional dilution of shares.
This news resulted in ECTE vaulting from around $2.50 a share to $3 in the following days.
Since then, ECTE has fallen back and found support at its 50-day simple moving average in the $2.70 area.
I think the change in CEO and the major shareholder demands will provide the catalyst to push ECTE higher in coming months. This company truly has potential, but it needs to be harnessed the correct way. The pressure provided by Platinum should force the needed changes.
Recommended Trade Setup:
-- Buy ECTE at the market price
-- Set stop-loss at $2.30
- Set initial price target at $6 for a potential 105% gain in six months