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Steel yourself for the September stock doldrums

Trader Christopher Lotito works on the floor of the New York Stock Exchange, Aug. 27, 2013. Worries about a potential military strike against Syria dragged the U.S. stock market down.

Richard Drew/AP

Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

I suffered from a distinct sinking feeling after spending a week bobbing on the waves of Lake Erie. But it wasn't my fondness for the local butter tarts that was weighing me down.

I was thinking about stocks at risk of being savaged this tax-loss selling season. It might be high time to give recent losers the heave-ho before they're hit with a wave of selling this fall.

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As I've mentioned previously, September is generally a bad month for the markets. Between 1926 and 2012, the largest 30 per cent of U.S. stocks – roughly the 500 largest stocks in the U.S. in recent years – lost an average of 0.8 per cent in the month, based on data from Dartmouth professor Kenneth French.

Is there any way to know which stocks are most susceptible to losses? The good professor's data offer some clues. He sorts U.S. stocks into different portfolios based on their size and their returns over the prior year, not including the most recent month.

Let's look at stocks in the top half of the market by size, a group that spans most of the large and mid-cap stocks that are likely to be in most investors' portfolios. He found that the stocks with the bottom 30 per cent of returns in this group fared particularly poorly in the fall, with losses in both both September and October. The average decline for the worst prior performers came to 1.9 per cent over the two-month period.

Statistics are one thing, but which stocks are at risk of taking home the booby prize this year? To find a few candidates I used S&P Capital IQ to pick out the worst 10 per cent of performers on the TSX over the last year that also suffered from negative earnings from continuing operations.

(To avoid being swamped by penny stocks, I also insisted that the candidates had to sport revenues of at least $250-million and share prices in excess of $2.)

The stocks that fit the bill this week are Atlantic Power, Barrick Gold, Fortress Paper, Legumex Walker, Newcrest Mining, Osisko Mining, and Walter Energy.

Despite their dismal recent performance, all is not lost for these companies. Most trade at a discount to book value, which potentially makes them attractive value prospects over the long-term, even if the short-term outlook isn't great.

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But Walter Energy deserves a little more attention because, to my eyes, the Birmingham, Ala., company runs the risk of running into more serious problems before making it to the long term.

The firm produces metallurgical coal for the global steel industry and its business has not been good in recent times due to declining coal prices. As a result, the company lost money in each of the last four quarters and it also generated negative cash flows from operations over the last three quarters.

To compound matters, the company carries a hefty debt load and it was recently forced to renegotiate the terms on it. As a result, the firm had to cut its quarterly dividend from $0.125 (U.S.) per share to $0.01 per share, which is a less than pleasing sign.

The string of bad news attracted the attention of a flock of short sellers. A whopping 46 per cent of its shares have been shorted. (Mind you, such extreme levels of short selling are potentially bullish because they could result in a short squeeze on even a little bit of good news.)

The combination of losses and high debt levels has deep-sixed more that a few companies over the years. I fear that Walter Energy's shareholders may suffer from more sinking feelings.

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