They Dump, You Scoop?

I recently ran across a website that monitors stocks that mutual funds are buying and selling. It features several lists. One, the "Global Top 10 Dumped Stocks," caught my eye. Here are the top 10, as of this morning:

• Network Appliance (Nasdaq: NTAP)        
• Harrah's Entertainment        
• Altria (NYSE: MO)
• Citigroup (NYSE: C)
• Dollar Tree Stores (Nasdaq: DLTR)
• Respironics
• Merck (NYSE: MRK)   
• Bear Stearns (NYSE: BSC)
• MGI Pharma
• Commerce Bancorp     

I imagine that many people would review the names and reason, reasonably, that mutual funds tend to be run by smart and trained professionals, whose analysis has led them to lose faith in these companies. Makes sense.

But there's another case to be made: Maybe some of these stocks are worth considering as investments. Consider:

• In the recently swooning and struggling market, many people have withdrawn funds from mutual funds, causing managers to sell off some holdings in order to fund withdrawals. If they didn't need the cash, managers may have otherwise hung on to some of these companies.
• Managers often work with short time frames in mind, looking to juice returns in the quarter. This can lead them to sell off holdings with great long-term prospects for which they simply have no patience.
• Many fund managers are simply just not that great at their jobs. The vast majority of managed mutual funds have failed to beat the market average. A simple index fund would beat them.

What to do
So what should you do? Well, all the selling may have led these companies' stocks to drop -- which, if they're otherwise attractive, can move them into bargain territory.

Just make sure you don't end up paying more for a company than it's really worth. Among other things, healthy free cash flow can differentiate good companies from bad ones. Even Warren Buffett has occasionally paid too much for some of his investments. Of course, figuring out what a stock is really worth is a lot easier said than done, and few analysts will agree on an intrinsic value.

Still, one simple way to get a general handle on valuation is to compare the recent price-to-earnings (P/E) ratio with the historic one. If it's lower than it has usually been, the stock may be worth looking into further.

In any event, if you see Wall Street investors dumping shares of a company you own, don't feel like you have to sell, too -- you might be passing up a bargain.