Bargains for the New Year: Part II

In September of 2004, The Motley Fool published my article on five ways to identify high-growth stocks trading at bargain prices. At that time, I was particularly impressed with one such stock, OmniVision Technologies. Since then, OmniVision has gained 113%.

In mid-January, six companies passed my bargain-hunting screen:

In my last article, I covered the three dogs of this group: Career Education Corp, Infocrossing, and Multimedia Games. This time, I'll focus on the three companies I believe have the most potential.

SFBC International
SFBC International provides clinical and laboratory drug testing services for the pharmaceutical, medical device, and biotech industries. Negative press reports during the past three months, including allegations that the company subjected patients and staff to dangerous conditions and that their Miami clinical facility was structurally unsafe, have caused the stock to drop from the mid-40's to the low-20's. And a few weeks back, the SEC announced an informal review of the company. Informal or not, SEC actions don't go away overnight, and any mention of SEC attention makes for jumpy investors.

Although third-quarter financial results were strong, the company will not emerge unscathed. One of SFBC's customers cancelled contracts with the company following the recent reports, and other customers could follow suit. SFBC canned its chairman (a subject of the SEC inquiry) and CEO, which raises the possibility that the bad news isn't finished. We can anticipate that SFBC will continue to incur costs associated with addressing the legacy of the negative attention, and we should not expect the fourth-quarter numbers to be a thing of beauty.

Still, SFBC has many of the characteristics we're looking for in an attractive bargain. Notably, the company's troubles are not the result of poor financials, and SFBC's strong historical performance indicates that the company knows how to run its business. In response to the depressed share price, the company recently announced a one-million-share buyback program (which would amount to more than 5% of outstanding shares). Finally, at 13.4 times forward P/E (a 45% discount to the industry average), the company is cheap. If SFBC can effectively address the negative charges in short order, its stock could enjoy quite a ride.

InfoSpace
InfoSpace develops search functionality for the Internet and mobile phone markets. Unless your head's been on vacation, you know that the search sector is one of the hottest things going. This popularity has drawn many players to the field, including behemoths like Google (NASDAQ:GOOG), Yahoo!, and Microsoft. But all of this attention is not necessarily bad. It means there's strong competition to incorporate new offerings, and the big guys have lots of cash to buy what they don't have time to develop. InfoSpace might be a tasty morsel. Here's why:

The company has a single-digit P/E ratio (compared to Google's P/E near 100 and Yahoo's P/E near 40). With $11.16 a share in cash and short-term investments and no debt, InfoSpace has a strong balance sheet. In the nine months ended Sept. 30, 2005, the company spent $62.2 million repurchasing 2.3 million shares of stock. Obviously, management believes the company is undervalued. In addition, InfoSpace's focus on emerging technologies, like local search for cell phones, places it in good standing for continued revenue growth.

So why has the stock lost half its value this year? Following strong first-quarter numbers, InfoSpace decreased revenue and earnings estimates for both the second and third quarters in 2005. But the company outpaced its revised earnings numbers in the third quarter and, a week ago, announced fourth-quarter results that handily beat estimates. Even so, the company is not in the clear. Tempering the good news, InfoSpace guided first-quarter earnings numbers lower and announced that its CFO was leaving.

However, even at current revenue, the company is attractively valued (my Foolish colleague Rick Munarriz recently came to a similar conclusion), and the generally improving numbers suggest that the company's struggles are only temporary.

SigmaTel
Since reporting stellar first-quarter results, SigmaTel has shed more than 75% of its market cap on the back of several earnings warnings. On Tuesday, the company was at it again, telling analysts to expect a loss of $0.10 to $0.17 per share in the current quarter. (Analysts had expected a 10-cent gain.)

SigmaTel's woes stem from several factors. First, Apple, which used SigmaTel's technology in the iPod Shuffle, switched to PortalPlayer -- a SigmaTel rival -- to provide the technology for the iPod nano. Second, sales of Windows-based MP3 players using SigmaTel's chip aren't growing as quickly as hoped. Finally, competitive pressures are driving down prices for semiconductor and flash-memory products in general. This is likely hurting SigmaTel's profit margins, as it has those of other semiconductor companies.

There's some light in SigmaTel's tunnel. The company carries almost no debt and is generating strong free cash flow. In addition, it carries nearly $3 per share in cash and short-term investments. SigmaTel is also working to increase and diversify its revenue streams by expanding its MP3 patent portfolio.

It's hard to ignore SigmaTel at its current valuation. However, the next several quarters won't be pretty, as the company fights to replace the lost Apple revenue in a competitive environment. I won't invest now, but I will put the company on my watch list and pay close attention to numbers, patents, and products in the coming quarters.

Foolish bottom line
These stocks provide some useful insights into bargain investing:

• When negative publicity hits, institutional investors often run for the exits. This can cause stock prices to plummet and create unique buying opportunities (assuming the highlighted issues are not chronic or fatal).
• Stock price is very sensitive to earnings warnings. Furthermore, issues that affect earnings are rarely fixed immediately: If a company delivers an earnings warning, it will likely warn again the next quarter.
• Look for strong financials and innovative products in a hot industry.

To recap, here's how I'd rank the six stocks derived from the bargain-hunting screen:

1. SFBC International
2. InfoSpace
3. SigmaTel
4. Career Education
5. Infocrossing
6. Multimedia Games

Screens are a good way to generate investment ideas, but they're only skin deep. If any of these companies pique your interest, dig into their annual earnings reports, which should be coming out in the next few weeks, and be sure to read the fine print. With a little research and careful analysis, you may find a bargain or two to give your portfolio a lift.

Related Foolishness:

• A Year for New Bargains
• Bargain Hunting
• A Value Test for SFBC
• InfoSpace Oddity
• InfoSpace Still Matters

If bargain investing is your cup of tea, try a free 30-day subscription to the Motley Fool Inside Value newsletter service, which offers two great bargain-basement picks a month.

Fool contributor Jim Schoettler loves bargains. At the time of publication, he did not own shares in any of the companies mentioned in this article. Please email him with your questions, comments, or tasteless humor.