The Under $3 Stock Everyone Hates is Signaling a 'Buy'

Shares of Groupon (NASDAQ: GRPN) have done nothing but fall since going public a year ago, losing 85% of their value.

So, why on earth would I suggest buying it?

For starters, shares are their cheapest ever. After a bearish earnings release and cautious forecast on Nov. 8, GRPN lost nearly a quarter of its value the next day. Technically, the stochastics indicator says the stock is dramatically oversold. There is also bullish divergence in MACD, a positive sign for the stock.

In other words, the baby may have been thrown out with the bathwater. I think the shares are likely to try to fill the gap formed the day after the earnings release and rally back toward the $4 level. And the downside risk can be limited with a stop-loss about $0.40 below current levels, making the risk-to-reward ratio a very attractive 2.6:1.

Fundamentally, what I also like about the "deal of the day" coupon website, is its shift in business model. And I'm not the only one who does. In the recently ended third quarter, private investment firm Tiger Global Management put $6 million into Groupon shares.

At the height of Groupon's allure, search giant Google (NASDAQ: GOOG) was willing to shell out $6 billion to acquire the coupon company. The deal ultimately fell through on antitrust concerns. Several competing daily deal sites then sprung up, such as Amazon's (NASDAQ: AMZN) Local and eBay's (NASDAQ: EBAY) Daily Deals. It seems Groupon's business model was just too easy to replicate.

Now, attempting to set itself apart from the competition, Groupon is expanding from a pure coupon site to a software solutions company that serves multiple clients, from online deal-seekers to small businesses.

Through the Groupon Payments app, customers can easily purchase their items directly through Groupon, via credit card. Groupon charges a fee every time a credit card is swiped. The online payment system is somewhat akin to PayPal, or the increasingly popular mobile phone card reader, Square, now used by Starbucks (NASDAQ: SBUX).

Groupon has also implemented an iPad-based point-of-sale solution for restaurants, called "Breadcrumb." The app enables servers to take orders online, search for menu items, process payments, split customer bills and view sales data in real-time. The software is designed so every time a customer pays the restaurant with their credit card, Groupon gets a cut.

As Groupon diversifies beyond daily coupon deals, it appears to be creating a more sustainable, more diverse and less replicable business model. Worst case, if none of these new directions prove successful, the company could be an attractive takeover target. It has a huge subscriber that, in itself, is likely worth multi-millions.

From a technical perspective, what I first want to point out is the stochastics indicator (an overbought/oversold measure) is at its most oversold level in the past several months. Further, the rally during the past several days puts it at the threshold of a buy signal. 

GRPN Chart

MACD also displays bullish divergence. Note how in September, when the shares were bottoming at around $4, MACD hit a low. Now that the shares have touched a low of $2.60, MACD is much stronger, a technical signal called bullish divergence. This indicator often foreshadows a turnaround.

The gap formed by the post-earnings release in the Nov. 9 trading session is almost $1 in height. The shares closed at $3.92 on Nov. 8 and opened at $3 on Nov. 9, ultimately careening to a low of $2.71 for the day. Volume was 116 million shares, nearly 8 times the 15.3 million average daily share volume of the past three months. That suggests massive institutional selling and leaves room for savvy traders to scoop up the shares on the cheap.

After a management change was announced this week, the stock has been putting in slightly higher bottoms and peaks. It appears to be finding support around the $2.60 level.

I believe GRPN could ultimately trade back to about $4 and attempt to close the gap before finding serious resistance. If the stock breaks the $2.60 low by very much, I will admit I'm wrong and accept my trading loss. 

This possible technical turnaround story is supported by bullish analyst forecasts. For the full 2012 year, analysts' project deal-seeking consumers will help push Groupon's revenue up 44%, to $2.3 billion, compared to $1.6 billion a year ago. In the first quarter of 2013, analysts' expect revenue will expand 18% to $661.4 million, compared to $559.3 million in the year-earlier quarter.

The earnings outlook is also optimistic. Due to international demand, analysts expect full-year 2012 earnings will turn positive, from -$0.72 in 2011 to +$0.17 this year. For the first quarter of 2013, earnings are expected to increase 50% to $0.03, from $0.02 in the comparable year-ago period. For the full year, analysts project 2013 earnings will be $0.24, a 41% increase from the $0.17 expected in 2012.

In addition to an upbeat fundamental growth outlook, the company is currently fairly valued. Groupon's 5-year expected PEG ratio (price to earnings divided by growth rate) is 0.63. In general, a PEG of 1 or under shows attractive valuation.

I am willing to bet the sell-off in GRPN's shares is overdone and a rally is more likely than a continued sell-off, so I plan to go long GRPN.

Recommended Trade Setup:

-- Buy GRPN at the market price
-- Set stop-loss at $2.49, slightly below current support
-- Set initial price target at $3.95 for a potential 36% gain
-- Risk/reward ratio: 2.6:1

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