Drop-Dead Gorgeous Stocks

"The idea of buying a former superstar stock at a discount price certainly has its attractions, but you've got to make sure you catch the haft -- not the blade."

So goes the thesis of my weekly Fool.com column "Get Ready for the Bounce." Therein, I run the 52-week-lows list compiled by Nasdaq.com through the "wisdom of crowds" meter that we call Motley Fool CAPS. And out the other end comes a list of stocks that have fallen so far, Foolish investors figure they're just bound to bounce back soon.

But is there a way to cash in on fallen angels who've plummeted even further? Perhaps. If a stock that's fallen for one year straight has headroom, then maybe a stock that's fallen even farther, and longer, has room to soar back even higher -- in which case, an apparently left-for-dead stock could offer us a drop-dead gorgeous entry price. We're going to test that thesis today, starting with five stocks that just hit their five-year lows:

 

Recent Price

CAPS Rating

(5 max):

Health Management Associates  (NYSE: HMA  )

$4.39

****

Mercer International (Nasdaq: MERC  )

$4.30

****

Guidance Software (Nasdaq: GUID  )

$4.93

****

Alcatel-Lucent  (NYSE: ALU  )

$4.50

**

CIT Group (NYSE: CIT  )

$10.70

**

Companies are selected from the "New 5-Year Lows" list published on MSN Money on Thursday. CAPS ratings from Motley Fool CAPS.

Left for dead? Or drop-dead gorgeous?
Each of the stocks listed above has shed between 35% and 75% of its value over the past year alone, and currently sits at or near its five-year low. Wall Street has left 'em all for dead, and well -- how do I put this gently? -- if you're a stock, and you hit your five-year low on a day like yesterday, then chances are you are a real basket case.

Regardless, Main Street sees the potential for some emergency resuscitation of at least two of these stocks: Mercer International and Health Management Associates. As for which patient I think stands the best chance of recovery, I'll give you a clue. In our hi-tech world of Adobe (Nasdaq: ADBE  ) Acrobat virtual documents, and Amazon.com (Nasdaq: AMZN  ) Kindle e-books, which industry has the better long-term growth prospects: Paper pulp, or health care?

Aha. Without further ado, let's start running down…

The bull case for Health Management Associates 

hybridinvestor introduced us to this operator of general acute care hospitals back in December 2006, calling HMA: "arguably one of the best managed hospital chains out there ... These guys do seem to have a knack for buying poorly run hospitals on the cheap and turning them into fairly profitable units that add to the bottom line long-term. No fear that hospitals are going away there either."

Sounds good in principle. Anyone care to elaborate? You there! CAPS All-Star TMTAirborne. What was it you were scribbling back in October? Ah, yes: "2 negatives that i can see, maybe 3 ... federally ran heathcare. Horrible debt, even though it brought on debt to keep buyers away and gave that debt to the share holders. And three, their business model is floundering. They buy hospitals where 'better' hospitals aren't, remodel, bring better management, and make a healthy profit. They haven't done that in awhile."

Well now, that doesn't sound so encouraging. But has HMA made any progress since last year? smallcapbigyield believes it has with this pitch from June: "They focus on the burbs, which is where a lot of the baby boomers are, and they're putting up crushing numbers this year: Net income, first quarter, 2008: $133M ... Net income, annual for 2007: $119M." In other words: "They're finally figuring out how to make money again."

How much money, you ask? Try $136 million in free cash flow over the past 12 months, and 189 million in net profit under GAAP. Those numbers give this stock a price-to-free cash flow ratio of about 8, and a P/E of less than 6.

Pretty tempting in light of analyst projections that have this company growing at an 11% clip over the next five years, don't you think?

That said, there's still the "horrible debt" situation that TMTAirborne highlighted. Right now, HMA's enterprise value-to-free cash flow ratio stands at a much less appealing 31 ratio. So Pay Dirt rec or no, I have to admit I'm a bit leery of this particular stock. True, the industry is destined to grow, and yes, the valuation looks tempting. Just mind the gap between "looks" and "is" on this one, Fools. HMA's not quite as cheap as meets the eye.

Time to chime in
But hey, that's just one Fool's opinion. Maybe you don't find the debt load particularly worrisome? If you've got another point of view, here's your chance to make your case. Just click on over to CAPS and tell us why.

Motley Fool CAPS: It's fun, it's free, and it just might make you famous.

Amazon.com is a Motley Fool Stock Advisor recommendation. Health Management Associates is a Motley Fool Hidden Gems Pay Dirt recommendation. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 339 out of more than 115,000 players. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 20, 2008, at 12:09 PM, 1234cody wrote:

    In responce to the article I would also like readers to know that HMA has taken out alot of their debt (300 mil) by partially selling a stake in some of their hospitals. They also completed the sale of their Little Rock hospital for cash which the plan to use for general corprate business including paying down dept. Their patient satifaction scores are improving and the insiders are buying.

    Friday I got off the phone with John Merriwether VP of finanical relations at HMA. He has assured me the guidence for 2008 has not changed. A good thing. We also talked for some time about incomming CEO Mr. Newsome and Mr. Whitman. The company thinks that Mr. Newsome will bring ten years knowledge of running the most profitable division of CYH to his position as HMA's new CEO. I like someone who knows how to make money! Mr. Whitman will not be selling his shares in the company and plans to hold for the long term. He still believes in the company and wants the reward. Once again guidence for 2008 has not changed. This is an overlooked company that is as nice as its hospitals.

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