The Next Big Bargain

The market offers bargain opportunities every day. You won't always know what the opportunity will be, but finding one can supercharge your portfolio.

Master investor Peter Lynch said that one advantage of running Fidelity Magellan (FMAGX) was its charter. It was a capital appreciation fund, giving Lynch the flexibility to buy in any investment situation. Big or small, constant or cyclical growth, asset plays or turnarounds -- you name it, Lynch bought it.

While we should follow his example and look for the best opportunities in any form -- growth stories, turnarounds, misunderstood stocks-- one type of investment can be particularly rewarding.

Limited-time-only sales
The best companies grow steadily year after year, right? Wrong. Great companies have plenty of miscues along the way, but the truly great companies recover.

If the initial step on the road to great returns is to invest in great companies, we must first know what it takes to be great. Read Built to Last or Good to Great by Jim Collins. Read Common Stocks, Uncommon Profits by super-investor Philip Fisher. Another master, Warren Buffett, offers his thoughts in his annual chairman's letters. Read those, too. Trust me -- you'll learn what makes a company great.

We'd all be rich if the only thing investors had to do was identify great companies. The second key, as Buffett advocates, is to buy them when they're on sale. And when do they go on sale? When there are problems.

At Inside Value, we know it's difficult to purchase companies surrounded by negativity. But the market offers the opportunity for big rewards -- if those problems are only temporary. Here are some recent examples of great companies selling at discount prices for a limited time:

35% off
Johnson & Johnson's products have probably touched all our lives at some point. Not just a Band-Aid maker, the company develops drugs and products that play a huge role in helping people get -- and stay -- well.

But July 2002 was not a good month for Johnson & Johnson. The Food and Drug Administration and the Department of Justice launched a criminal investigation into the quality of its anti-anemia drug Eprex after the drug was linked to serious illnesses in Europe and Canada.

That typically doesn't help your share price. However, if you were able to diagnose this as a great company that could recover from the trauma, you could have earned a 56% return. Recently, the press has cited elevated risks in using drug-coated stents (Boston Scientific (NYSE:BSX) is also approved to sell the product). That's caused some uncertainty -- and you have to wonder if current share prices are a bargain today.

60% off
Financial services company Capital One also suffered a blow in July 2002. Regulators required the company to boost its reserves for bad loans by $247 million, and to make changes to its infrastructure as it pursued growth in the subprime lending market.

Increases for reserves means less profit and implies that the company may have been too aggressive with its accounting policies. Investors didn't much care for the news, and the class action lawsuit filed shortly afterward certainly didn't help. The stock fell 39% in one day, and eventually dropped a total of 60% to its low of $24.70. But as you can see from the table above, great companies don't stay down for long.

95% off
The Enron collapse took down many energy giants, including Calpine, Dynegy (NYSE:DYN), AES, Reliant (NYSE:RRI), and El Paso. All of them watched their stock prices drop 90% from all-time highs.

Calpine's problem was in overpaying for its generation assets, then not being able to produce meaningful returns from them. Yeah, value destruction.

Don't get me wrong: El Paso had plenty of troubles of its own, including overstating its natural gas reserves, manipulating natural gas markets, restating its financial statements, declining credit ratings, a large debt burden, and class action lawsuits. However, despite the issues, El Paso's assets continued to generate cash flow. Value creation.

Today, Calpine is trying to emerge from bankruptcy. El Paso? It's still getting back on track. But fire-sale buyers who bought El Paso near the bottom are up nearly 400%!

Today's sales
Within the market, there are plenty of underappreciated, unloved, and misunderstood businesses. Add the right catalyst and you've got opportunity.

Wallboard specialist USG (NYSE:USG) is still down from its highs. With slowing new home construction as well as fewer do-it-yourselfers making upgrades lately, it's no wonder the stock has fallen from its high over the past year.

Despite the troubling macroeconomic environment, USG continues to invest in its future to maintain an advantage as a low-cost producer of building materials. That fact has not gone unnoticed -- big-time investors such as Warren Buffett, Bruce Berkowitz, and Wally Weitz have taken stakes in the company. Apparently Inside Value advisor Philip Durell isn't the only one who thinks the stock is cheap and is willing to hold it to reap the gains.

On sale tomorrow ...
What will be tomorrow's big bargain? That's what Durell and his Inside Value team dedicate themselves to finding. If you'd like to take a look at the stocks we're recommending today, click here to join our community free for 30 days. There is no obligation to subscribe.

This article was originally published on June 24, 2005. It has been updated.

David Meier owns shares of AES. Johnson & Johnson is a Motley Fool Income Investor recommendation. USG is an Inside Value selection. The Motley Fool has a disclosure policy.