6 Tantalizing Stocks Investors Are Too Scared to Buy

Something needs to be wrong.

That's what I tell house hunters in the Washington, D.C., area, where The Motley Fool's offices are located.

Thanks to a relatively stable local economy with a fairly low 6% unemployment rate, housing prices here can still provide some post-bubble sticker shock. But savvy homebuyers find deals by looking for traits that discourage other potential buyers. Whereas others see problems in terms like "fixer-upper," "short sale," or "nine months on the market," the savvy see opportunity.

As writer Charles R. Swindoll put it, "We are all faced with a series of great opportunities brilliantly disguised as impossible situations."

The current stock market is analogous. It's down from previous heights, but you can still get burned overpaying for the stock that "shows well."

An example of the kind of stock we're looking for
To be clear, subtlety isn't rewarded in bargain hunting. We want situations with huge glaring problems that scare the dickens out of investors. In short, we want a situation like Tempur-Pedic (NYSE: TPX  ) 16 months ago.

During an economywide liquidity crisis, Tempur-Pedic had a net debt-to-equity ratio of almost 6:1. Even in normal circumstances, red flags usually start going up at 1:1. Worse, it made premium mattresses priced well into the thousands. Swedish TEMPUR material or not, a worsening economy had a very real chance of wiping out a highly leveraged company that peddled high-end furniture to a populace losing more sleep over the possibility of foreclosure than the threat of a gimpy back.

Tempur-Pedic's problems were as subtle as a late-night infomercial, and investors pushed its stock price down from highs in the upper $30's to a low of $3.84.

However, the situation was never as dire as the reaction. Yes, Tempur-Pedic faced real problems, and the chances of bankruptcy were present. But even at its low point, it had positive earnings (barely) and solid, if unspectacular, free cash flows. And it was still a premium brand name in the mattress industry.

If it survived, the upside would be orders of magnitude greater than its downside. And that's exactly what happened. As overall market fears subsided, Tempur-Pedic rocketed from $3.84 back into the $30s, where it stands today.

Today's Tempur-Pedics
Tempur-Pedic may still have some upside left at today's prices, but general investor confidence is much higher, Tempur-Pedic's net-debt-to-equity ratio has fallen closer to 3:1, and its profitability has strengthened.

While investors are no longer cowering at the sight of Tempur-Pedic's ticker, here are six stocks the market's doubting now:

Company

Fall from peak*

The fear

Transocean (NYSE: RIG  )

68%

It's a deepwater driller in a deepwater-unfriendly world.

Gannett (NYSE: GCI  )

86%

Newspapers are dead.

Sirius XM (Nasdaq: SIRI  )

63%

Excessive debt combined with a threatened business model.

E*Trade (NYSE: ETFC  )

77%

A toxic balance sheet.

Melco Crown (Nasdaq: MPEL  )

76%

Oversupply due to fierce competition.

FormFactor (Nasdaq: FORM  )

76%

Permanent impairment of profitability in a wildly cyclical industry.

Source: Capital IQ (a Standard & Poor's company).
*Figures based on market capitalization.

Let me explain what you have to believe to buy these stocks.

Transocean's Deepwater Horizon rig was involved in the BP oil spill. The catastrophe dropped Transocean's stock from around $90 to its current price in the low $50's. Those who believe Transocean's liability in the incident will be minor, and that fears for the deepwater industry worldwide (most of Transocean's $11.6 billion in sales are outside the U.S.) are overblown, will want to look into this company.

My fellow Fool Morgan Housel highlighted USA TODAY publisher Gannett as "the best company in an absolutely terrible industry (newspapers)." Enough said.

A bull on Sirius XM would have to believe that it can handle its debt load by increasing its 19.5 million subscriber count profitably (partially by reducing churn), continuing to lower its cost structure, and increasing its current $11.48 average monthly revenue per subscriber.

E*TRADE's earnings have been battered by write-offs on the toxic assets it collected during the housing bubble. This is clearly a "How bad is the balance sheet?" situation.

Melco Crown runs casinos in Macau -- the "it" destination for Chinese gamblers. Macau surpassed Las Vegas to become the world's largest gambling center back in 2006. Investors mostly fear oversupply by Melco and its competitors. For Melco to be a buy, gambling demand has to outstrip the temptation to oversupply.

FormFactor makes testing equipment for the semiconductor industry. The industry as a whole has been on a rollercoaster ride, and FormFactor has suffered painful losses and a management shakeup recently. However, the company boasts 80% of its market capitalization in cash. In other words, if the stock is trading at $10, you're really getting its business operations for $2.

A final thought
It's possible that none of these stocks will follow Tempur-Pedic's comeback track -- they all do have serious problems. But these are the kinds of situations that reward brave investors who can perform careful analysis and practice patient contrarianism.

Let's discuss in the comments section below.

Anand Chokkavelu owns shares of Tempur-Pedic, Transocean, Sirius, Melco Crown, and Form Factor. Melco Crown Entertainment is a Motley Fool Global Gainspick. Motley Fool Options has recommended a bull call spread position on FormFactor, which is a Motley Fool Hidden Gemsrecommendation. The Fool owns shares of FormFactor. The Fool has a disclosure policy.


Read/Post Comments (30) | Recommend This Article (88)

Comments from our Foolish Readers

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 July 12, 2010, at 1:04 PM, steven107 wrote:

    Don't forget BP. :)

    Though it's not a popular choice.

    I bought some RIG and BP, to see how things play out.

  • Report this Comment On July 12, 2010, at 1:15 PM, TMFBomb wrote:

    BP's on my radar, but I've so far preferred the bouce-back prospects of RIG.

    -Anand (TMFBomb)

  • Report this Comment On July 12, 2010, at 2:08 PM, ragedmaximus wrote:

    YRCW hit bottom 11 cents positive earnings from massive debt headed back to .80 cents soon

  • Report this Comment On July 12, 2010, at 2:46 PM, Tradersinfo wrote:

    Of the mentioned stocks, I would consider ETFC, MPEL and RIG. E*trade I would purchase above $14.00 for the longer-term, as its debt situation has improved substantially in recent months. MPEL because of its excellent growth prospects and valuation. RIG I would buy because of both.

  • Report this Comment On July 12, 2010, at 5:41 PM, plange01 wrote:

    there is nothing tantalizing about sirius.back on delisting notice and moving toward banruptcy...a strong sell on this one!!

  • Report this Comment On July 12, 2010, at 6:22 PM, fridayeyes wrote:

    Of these, I'd consider RIG only.

    Everyone I know who has XM radio loves it. My folks have lifetime subs for each of their cars. I wish I felt better about the fundamentals, tho - cuz I don't.

  • Report this Comment On July 12, 2010, at 8:08 PM, SeeknDestry wrote:

    I like RIG much better then BP. BP is going to carry the negative publicity and most of the liabilities that are going to come from this. I bet 99% of America never heard of BP before this, wonder what they think of them now...

    Sure, they could be at a good value, but why not pick up RIG and gain the benefit of the price drop, without the bad branding, possible liabilities damage and overall added risk?

  • Report this Comment On July 12, 2010, at 8:18 PM, tomd728 wrote:

    Me worry ?

    No news to the prior posters but I like

    RIG a lot in here a lot.

    Where is Rig going.......$40 ? Great buy me some more.

    Tom

  • Report this Comment On July 12, 2010, at 8:55 PM, 7jspnc wrote:

    Where was your recommendation to buy TPX when this stock was $3,00 +??? Or did I miss something?

  • Report this Comment On July 12, 2010, at 9:17 PM, Howard1ii wrote:

    BP will drag RIG down with them. The liabilities for damages will end up being shared. BP is playing nice now because they want Obama off their back, but when push comes to shove, they will "lawyer-up" and RIG will be a target to share the costs

  • Report this Comment On July 12, 2010, at 11:07 PM, jm7700229 wrote:

    The wildcard for both BP and RIG is the US legal quagmire. The lawsuits will name both (among many others), so BP won't be able to push off any liability assessed against it. In RIG's favor is the ignorance of the people who will be on the jury, who are furious at BP and don't know nuthin' 'bout no RIG.

    Still, I think the ultimate liability will be manageable for both and will play out over 20 or 30 years, not the next 24 months. Both are very attractively priced, and I'm in for BP and considering RIG.

    I hope to see SIRI go belly up. When they signed Howard Stern, who belongs in jail as the wife of a really brutal sex offender, for half-a-billion dollars, I dropped my account. He is a sick animal, and anyone who listens to him is a sick animal. And any company that would hire him deserves to fail. And take its investors with it.

  • Report this Comment On July 12, 2010, at 11:26 PM, aamcadams wrote:

    My SIRI system is nothing like what I signed up for, service has gone way down & prices have done nothing but go up. I agree BP could drag down RIG for years [look what they've done to the rest of the industry say, FWLT or CVX]. I get a headache everytime I try & figure ETFC. Finally I know nxt to nothing about the rest, which I suspect is a good thing concerning GCI! Now having said all that, place my bets on RIG & FORM [BP was beyond irresponsible, & HAL should pick-up the rest of the tab, is there any disaster they haven't been associated with?]. FORM sounds like another co. I cant think of right now thats had good performance recently (amat maybe?). Good Hunting Fools...

  • Report this Comment On July 13, 2010, at 12:19 AM, cept4Grace wrote:

    Sold BP, RIG and APC three days after the incident!

    Have held off buying back in until now. Thought of "bottom fishing" several times recently, but that would be fishing in deeper water than I am comfortable. I now believe all three are in a definite recovery, although I am still not willing to risk more than a 1% position. APC had 25% interest in the endeavor, but were not directly in control of the drilling operation, but BP has huge resources compared to APC. RIG will undoubtedly be involved in litigation over the spill, but American ire is overwhelmingly directed at BP.

  • Report this Comment On July 13, 2010, at 10:45 AM, MikeCoop wrote:

    Sirius-ly? I just don't see this company lasting much longer at all. I know NO ONE who subscribes. I know I certainly won't subscribe when I can still listen to regular radio which doesn't require expensive satellite access for free. . . If I owned this stock, I'd dump it now. I sure as heck won't buy any!

  • Report this Comment On July 13, 2010, at 10:47 AM, Usnzth wrote:

    Instead of BP or RIG, why not NE? Solid balance sheet with a price drop sympathetic to those who were really hurt by the spill. My guess is that Noble will bounce back much faster than either of the other two.

    I backed my guess with real money on June 8th. I got very lucky and bought at $26.40, just 17 cents off the 52 week low. (I just wanted to brag a little, even though it was a fluke.)

    Up almost 22% in the first month, and a long way to go. Still a bargain with a P/E just over 5.

  • Report this Comment On July 13, 2010, at 11:30 AM, ChuckWoolery wrote:

    RIG looks like the smartest play here. Not sure how the losses will be divided up with BP and if they will go after RIG to share them but I have to agree with jm7700229.

    RIG is a smaller fish that has not received the bad publicity the size of BP. Wait and see approach.

  • Report this Comment On July 16, 2010, at 12:56 PM, PositiveMojo wrote:

    It's high risk to buy poorly managed companies. Why do that when you can buy well managed companies and make money?

  • Report this Comment On July 16, 2010, at 1:18 PM, sailor5030 wrote:

    You have to belive that BP will come back. it's too big and they pull in too much cash. Worse case senerio they get sold or chopped up. I put some in my IRA. So far, so good. As for Rig, you have to believe that the long term will mean more and more deepwater drilling all around the world, after some initial liability claims. The other stocks represent risks that I cannot assess, so I'm staying away form them. .

  • Report this Comment On July 16, 2010, at 1:48 PM, Irishbetter wrote:

    Don't kid yourselves. This is speculation and not investment.

    “There are two times in a man's life when he should not speculate: when he can't afford it, and when he can.” – Mark Twain

  • Report this Comment On July 16, 2010, at 2:11 PM, tylee100 wrote:

    Anyone who has ever really tried Sirius/XM radio will agree that it has a great product. I got it free with my new GMC Terrain and I love it. I now am paying for the service and would never listen to anything else. There are never any ads. I could listen to every World Cup match if I had wanted to. They will succeed. Long haul truckers swear by it. You get the same stations everywhere in the US. When we recently traveled we listened to the comedy channels for the whole trip. It was very funny and relaxing.

    Don't criticize something you have not tried. No I don't care for Mr Stern and I don't listen to him. But that should not condemn the whole product.

  • Report this Comment On July 16, 2010, at 2:21 PM, celibedache wrote:

    Upthread somebody mentioned YRCW, which is a distressed play I've been thinking about for some time. What do people think about this one?

  • Report this Comment On July 16, 2010, at 2:36 PM, swiver wrote:

    RIG have a specific number of rigs, now less 1. As with Diamond Offshore the loss of, or slowdown in deep-water drilling in GoM will result in their rigs going elsewhere in the world. These companies are already multinational.

    BP can sell assets, but must do one other thing: the company MUST start inspecting its assets properly. Refineries and pipelines are getting harder to maintain as we go to more H2S in oil and gas, and that ultimately means better NDT (as they used in Alaska, but after the pipeline event there). You can't wring more and more profit out of older and older facilities without doing more and more NDT & maintenance.

    I bought both, and had owned RIG when it was Global marine.

  • Report this Comment On July 16, 2010, at 3:20 PM, mtracy9 wrote:

    Warren Buffett: 'Invest only in companies you understand.' To date, Buffett has not owned a technology company; he admits he would be unable to understand the company well enough to make an informed judgment. --"The Warren Buffett Way" by Robert Hagstrom

    http://shouldersofgiantsinvestor.com/

  • Report this Comment On July 16, 2010, at 7:34 PM, Winnerfrommidlan wrote:

    I think FORM is the best bet of the lot. BP and RIG will be under the gun for some time to come. With FORM, they have some uniqueness and the industry is picking up strongly. It could be a big winner and I don't think the others will.

  • Report this Comment On July 16, 2010, at 9:04 PM, TMFBomb wrote:

    @tylee100,

    I actually have had XM in my car for years. I love the product and still own some shares of Sirius (sigh).

    -Anand

  • Report this Comment On July 17, 2010, at 12:56 PM, philkek wrote:

    Thanks MF and other fools writing here about these business opportunities. You have given me much to think about as i now continue doing more fundamental homework before I make my decisions to invest. These companies noted here do offer fear and greed challenges. You all offer a STARTING place for more research. MF advises investors to do your own research before investing money for potential gains. Sometimes I win, sometimes I lose, but always research first. Fool on for profits.

  • Report this Comment On July 18, 2010, at 10:45 AM, wolfhounds wrote:

    MPEL, as of 3/31/10, Cash - $250m, LT debt - $1,741. I think the author should reconsider his opinion.

  • Report this Comment On July 19, 2010, at 12:19 PM, vancouverromeo wrote:

    AERL might be a better Macau play : gets commission from Macau casinos for bringing in customers. 5x P/E, $40 million project income 2010, $19 million cash in hand, share price $5.60, > 100% year on year earnings growth

    15 million shares + some outsanding warrants (AERLW)

    Here is a more thorough description:

    http://www.spacanalytics.com/modules/deals/frontend/spac_ove...

  • Report this Comment On July 27, 2010, at 3:01 AM, foolishbk wrote:

    I bought $5K of BP when it tanked recently because Obama was gronking on it, figuring that the future dividend would pay me nicely for holding it, even though it was suspended for a year. However, when I heard they were being suspected of paying off Libya for drilling rights by working to get the Lockerby bomber out, I couldn't stomach the possibility it was true. I dove out for a modest profit.

  • Report this Comment On August 12, 2010, at 5:38 AM, thidmark wrote:

    RIG shares have been pummeled much worse than BP. That makes absolutely no sense to me. I have made two purchases of RIG and might do more.

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