Some companies are obviously great investments -- in hindsight. Yet, for every stock out there screaming "buy me," others simply give us a nudge and a nod. How can we tell tomorrow's obviously great investments from the thousands of pretenders?
The stars' walk of fame
On Motley Fool CAPS, these opportunities can be found among our four-star stocks. In CAPS' proprietary ratings system, they rank higher than most of the other 5,300 starred companies, but they're just shy of superstardom. While all the attention might be focused on their five-star peers, we can sift through CAPS to find four-star firms approaching greatness, such as:
- American Capital (Nasdaq: ACAS )
- Coach (NYSE: COH )
- Flextronics International (Nasdaq: FLEX )
- Healthways (Nasdaq: HWAY )
- Imax (Nasdaq: IMAX )
Some of these names might surprise you. Coach, for example, has been in the forefront of aspirational style for years. Almost great? Even familiar names can still offer some of the best opportunities. Perhaps we've just forgotten the potential they still hold. However, the 130,000-plus CAPS members chose these companies as less obvious sources for tomorrow's great buys, so let's see why they might merit your attention.
In the sight of greatness?
Although Coach may be surprising, American Capital seems even more so. The private equity and asset management firm seems to be teetering on the brink of disaster after having defaulted on its loans, bringing into question its viability as a going concern. The moribund economy and still-frozen credit markets may have done in the business development company, an affliction also facing Allied Capital (NYSE: ALD ) .
Market-to-market accounting, which requires companies to value their assets at what they would be able to get for them in the marketplace rather than some ephemeral pulled-out-of-the-air valuation the company assigns to it, has impacted not just banks and hedge fund operators like Fortress Investment Group (NYSE: FIG ) , but just about every asset management group out there. It's one of the reasons that the accounting rule is under heavy assault now, and some businesses want to do away with it.
BDCs and small business lenders like American Capital invest in small and mid-sized companies in return for an equity position in their operations. It has stakes in dozens of firms, most which have yet to blaze upon the scene, but also in some better-known names like Riddell Sports Group, Marcal Paper, and Piper Aircraft. The goal is to eventually sell its investment positions at a profit and distribute the proceeds to shareholders in the form of dividends. It's not necessarily a quick turnaround business: It's held Electrolux since 1998 and Marcal since 2001.
In the most recent quarter, American Capital lost almost $1.7 billion, or $8.13 per share, compared to a loss of just $243 million, or $1.27 per share, a year ago as the markets collapsed and credit dried up, making it all but impossible to get an acceptable offer for its businesses, let alone sell them. It's willing to wait rather than sell assets at fire-sale prices, but that is where it ran afoul of its debt covenants. American Capital's arrangements require that the BDC's assets remain above 200% of its current debt, so while it has enough cash to cover debt payments and service the firms in its portfolio, it is trying to get a waiver from its lenders to breach those levels in the current environment, which has depressed the value of all of its assets.
So, on the surface it looks like a head-scratcher for some investors in the CAPS community to think American Capital will outperform the market, yet there is indeed still hope that it will survive -- and perhaps thrive -- in its current form.
Top-rated All-Star CAPS member stockmajor agrees that American Capital's ability to continue as a going concern centers on getting the waivers, but thinks the BDC has all of the ingredients in place to fully recover:
At this point the near term future of [American Capital] largely depends upon the ongoing negotiations concerning the breached debt covenants. If ACAS can come to an agreement with their creditors and restructure this debt, I believe that we will see a jump in their stock value and that they will be in a much better position for weathering this storm. Combine that with easing of the Mark to Market regulations and ACAS should have all that it needs to fully recover. Under this scenario, I believe that we will eventually, with long term recovery along with the macro economy, see stock value back to the $30 to $50 range. If ACAS and their creditors can not come to an agreement, the debt will be accelerated. This could ultimately push ACAS in to Chapter 11 reorganization bankruptcy. This would cause the stock value to crash and equity holders could end up losing all of their money. However, as was stated in the recent earnings call, under a Chapter 11 reorganization it is quite possible that most, if not all, of shareholder value could be preserved as long as ACAS can demonstrate that they can pay their bills and run their business profitably going forward post bankruptcy. I believe that they would be able to prove this to the judge, especially with the easing of the Mark to Market rules. Therefore, in my opinion, full recovery for ACAS would eventually occur, though it would just take a bit longer.
A great opportunity for you
These four-star investments seem to be on their way to five-star greatness, and it pays to start your own research on these stocks on Motley Fool CAPS. Read a company's financial reports, scrutinize key data and charts, and examine the comments your fellow investors have made -- all from a stock's CAPS page.
Sign up today for the completely free service, and let us hear what you have to say about the great and almost-great companies that interest you.