Contrarian Shopping List

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." -- Warren Buffett

Out of the quadrillions of quotations quarried from that most loquacious of quotationists, this one holds a special place in the hearts of Foolish investors. Are you looking to "buy low" so as to later "sell high?" If so, your best chance of getting that initial, low entry price comes when panicked sellers are unloading their shares at whatever price is on offer.

In today's column, we search the ranks of Wall Street's motivated sellers, and note which stocks they're most frantic to unload. Therein may lie the makings of a contrarian investor's shopping list. But don't just take my word for it. Before you decide to go in through Wall Street's out door, check your thinking against the collective intelligence of Motley Fool CAPS investors.

Today's contenders include:

The problem with pessimism
There's a downside to going against the grain on Wall Street. When professional traders get pessimistic, their grim outlook can become a self-fulfilling prophecy -- at least in the short term. The more desperate institutions become to abandon a stock, the lower the price they'll accept to get rid of it. And as their "ask" prices drop, the "bid" prices of buyers will fall in tandem, creating the very price decline that they feared in the first place.

Until the selling stops.

In through the out door
When it will stop is anybody's guess. But until it does, savvy investors have a chance to "get greedy," and snap up some bargains from these fearful sellers (if bargains they truly be). This week, investors believe they have found a steal of a deal in the stock of pharmacy benefits manager SXC Health Solutions. What's so attractive about a stock that's lost 60% of its market cap in the last three months? That's what we're about to find out.

The bull case for SXC Health Solutions
CAPS All-Star NetscribeSoftwre introduces us to the company:

Systems Xcellence Inc. (SXC) is involved in the business of providing health care information technology solutions and services primarily in U.S. and Canada. It offers pharmacy benefit management services and software products to different variety of customers in the pharmaceutical supply chain, though payor customers that include managed care organizations, blue cross organizations and government agencies, contribute over 60% to the revenue tally. SXC's total revenue comprises of inflows from transaction processing, maintenance, systems sales, and professional services. The transaction processing and maintenance generate about 65% of the revenues, and as they are recurring in nature, it gives a level of certainty to the future cash flows.

The influence of IT on the pharmaceutical supply chain is witnessing a growing influence. With approximately more than 3.6 billion pharmacy prescriptions written in U.S in a year, the potential for providing specific software and solutions is robust. Moreover, an aging population base, rising drug prices, and increased advertisings are having a positive impact on the industry, creating a possible market opportunity of around $4.5 billion annually...

Looking ahead in 2007, the transaction processing volumes are expected to be strong, leading to sturdy recurring revenues for the company. Moreover, the strong fundamentals of the pharmaceutical industry, the growing adoption of IT for pharmaceutical benefits management, and growing volumes of customer base, makes SXC a healthy investment.

The Fool's own TMFCanuck agrees that this is "A tiny company that will do well," adding that the company has net operating losses from its unprofitable past, with which "to shield future profits."

So why is such a popular company sitting among Wall Street's rejects today? All-Star investor pennysplants explains that SXC took a big hit last month, when an apparent clerical error in its bid for a pharmacy benefits management contract in Georgia cost it the deal. UnitedHealth (NYSE:UNH) won the contract instead.

Despite the contract loss, pennysplants says of SXC:

I love the business model (recurring transaction fees) and the drug prescription / health management sector. Cash generating machine. Until the Aug 22 2007 contract SNAFU, SXCI was too richly valued for my blood.

Yet if you look at the chart, it seems clear that the Georgia contract isn't all that's been ailing SXC. This stock was tumbling long before August's news rolled around. Has it finally sunk low enough to interest not just pennysplants, but you as well?

I'm not so sure. Yes, the P/E of 22 looks fair relative to the 20% annual profits growth that analysts expect from SXC. But look a little deeper, and you'll find a firm generating only $5.3 million in free cash flow over the last 12 months. That's less than half the income it reports under GAAP, giving the company a much less attractive price-to-free cash flow ratio of 50. Before buying into this one, I think I'd want to see considerably more cash profits, or proof that growth won't stall with the loss of the Georgia contract. Preferably both.

Looking for a better play on the long-term trend of increasing health-care and pharmacy usage in the United States? At the Fool's deep value investing newsletter, Motley Fool Inside Value, we've got two such ideas for you -- and only one of them is UnitedHealth, already mentioned above. To discover the other company, try the service out for free.