Whacked-Out Stocks, Great Opportunities

We find ourselves in the midst of a ferocious bear market, a frightening recession, and a huge financial crisis. Amid all these fears, many stocks aren't trading on fundamentals; their prices instead reflect nothing but pessimism.

As illogical and daunting as it may sound, this can actually be a blessing -- and a guarantee of outsized long-term returns -- for smart, calm, diligent investors.

You're kidding, right?
I have been an Urban Outfitters (Nasdaq: URBN) shareholder for quite a few years now. I even held on to the stock through the turbulence that followed its serious fashion misstep in 2006. Urban Outfitters needed to coax droves of customers back through its doors, and it pulled off that feat with flying colors. Its stock recovered, surging to $38 a share at one point in the last year.

At my last check, Urban Outfitters shares now trade at about $15 per share, the level the stock hit in 2006, when the retailer was having real problems with its actual business. The stock's beaten down again now, but the problems with its business are nowhere in sight.

Urban Outfitters has done remarkably well this year despite the gloomy consumer spending environment, growing earnings 31% last quarter. Yet its shares have gotten whacked again. This time, however, they're simply getting spanked along with the broader market. (Admittedly, a line of legalese in its recently filed 10-Q apparently spooked investors a bit, too.)

With a price-to-earnings ratio of 12 -- insanely low, when you consider analysts expect 20% growth over the next five years -- Urban Outfitters is a good example of a stock whose fundamentals have gone out the window. Its share price more reflects pessimistic psychology than any realistic assessment of operational strength or growth. It's a quality stock that's been beaten down simply because it's part of a suffering industry, even though Urban Outfitters' actual performance has been an outlier in these terrible times.

For savvy investors, this type of situation spells opportunity.

Taken to the woodshed
Concerns about the financial crisis, the recession, and their effects on consumer spending are whacking stocks across the board. Check out just a few of the stocks that have hit new 52-week lows as of this writing:

* Based on current-year earnings estimates. Data from Yahoo! Finance.

Severely beaten-down stocks are probably not unfamiliar to you; precipitous drops in stock prices and single-digit price-to-earnings ratios are common these days. Buy-and-hold investors know that such across-the-board drubbings create great opportunities to snap up bargains.

Of course, investors shouldn't be arbitrarily snapping up stocks just because they recently hit 52-week lows, although such lists are a good place to start coming up with ideas.

After all, we are in a dangerous economic climate, and some companies do face real risks to their businesses. Investors must tread carefully. For example, there are good reasons why Dow Chemical's stock got taken to the woodshed. Its joint venture with a state-owned Kuwaiti oil company fell through, leaving Dow holding the bag for financing its $15 billion acquisition of Rohm & Haas. For every month the company delays, it's fined another $100 million. Adding insult to injury, Moody's and Standard & Poor's also cut their credit ratings on Dow.

Opportunities abound when so much pessimism is at hand, but investors must choose their stocks with great discrimination.

A whacked-out but wise stock shopping list
My dream stocks these days, like Urban Outfitters, are great businesses with smart management teams, plenty of cash on their balance sheets, and little or no debt.

Two such names that come to mind are Apple (Nasdaq: AAPL) and Netflix (Nasdaq: NFLX). Both have high-margin, growing businesses, superb balance sheets, and are led by dedicated and talented founders. (Well, assuming Apple CEO Steve Jobs returns from his recently announced six-month hiatus.) Not coincidentally, they're both recommendations of Fool co-founders David and Tom Gardner's Stock Advisor service, which is currently beating the market by 29 points.

To see what other stocks David and Tom are recommending today, simply click here for a free 30-day guest pass to Stock Advisor. (Through Tuesday, Stock Advisor is offering a special inauguration sale -- you can get a 12-month membership for $99, a more than 30% discount. Click here for full details.)

Nothing wacky about great opportunities
These are unquestionably scary times, but with the proverbial blood running in the streets, investors have a great opportunity to seek out high-quality stocks that will survive and thrive over the long haul. Making careful choices of stock prices that are fundamentally out of whack is a great way to build an excellent long-term portfolio.  

Alyce Lomax owns shares of Urban Outfitters. Activision Blizzard, Netflix, and Apple are Motley Fool Stock Advisor recommendations. Steelcase and Dow Chemical are former Motley Fool Income Investor picks. Take-Two Interactive is a Motley Fool Rule Breakers recommendation. The Fool has a disclosure policy.