Get Ready for the Bounce

"Don't catch a falling knife," as the old saw commands. (Pardon my mixing a cutlery metaphor.) 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. That's where Motley Fool CAPS comes in.

Today, we once again stand beneath Mr. Market's silverware drawer, measuring which knives have fallen furthest. Then we'll call on CAPS to ask which of these stocks -- if any -- Foolish investors believe are ready for a rebound. Let's meet today's list of contenders, drawn from the latest "52-Week Lows" list at WSJ.com:

Companies are selected from the "New Highs & Lows" lists published on WSJ.com on Friday last week. 52-week high, recent price, and CAPS ratings from Motley Fool CAPS.

A Chinese curse upon your house
It's been an interesting couple of weeks for stock investors. (And what is it the Chinese say about living in "interesting times?") Two Thursdays back, we saw the market sell off to the tune of 10% for no particular reason. Then a week ago, it bounced right back on the grand news that Europe's in such bad shape that it has to have the IMF bail it out. Weird. Somehow, the market wound up ending last week "up" from where it started, but not everyone enjoyed the bounce.

Up above you see three stocks that have yet to recover from year-long tumbles: SunPower, which disappointed on earnings and revenue last week; Nokia, which is tussling with iPhone magnate Apple in a patent dispute, even as it faces management turmoil within its own ranks; and Shanda, which, well, honestly, I'm not sure why Shanda's still suffering.

It's been more than two months since Shanda reported fourth-quarter earnings, and warned that the upcoming Q1 might be a bit weak. That should have been plenty of time to price the bad news into the stock, and lay the groundwork for a recovery. Yet while the five-star CAPS rating tells us investors are optimistic, the stock's still scraping bottom as the clock ticks toward Q1 earnings.

Let's check in with CAPS members and see why they're so confident that Shanda will outperform.

The bull case for Shanda Games
What's got Shanda down in the dumps? CAPS member creamcityjw has a theory: "Two analysts (Goldman and Citi) downgraded to Hold and Citi cut its price target. That said, the target dropped from $13.50 to $9, a 35% premium from current levels."

CAPS All-Star mrindependent is less sure, about the reasoning, at least: "Mr. Market is somewhat unclear about his reasons for despising Shanda Games at the moment, but my guesses are as follows. First, Mr. Market is disturbed by the recent spinoff into two separate companies. Second, Mr. Market does not like the fact that Chinese officials recently cracked down on the online gambling industry. Third, Mr. Market is disappointed at the company's recent earnings guidance for the first quarter of 2010."

So there's some reason for pessimism here. Yet, according to Swingtime1, the pros vastly outweigh the cons at Shanda Games: "fy/2010 diluted eps is .75, which with a P/E of 10 is 7.50 share value. That fy/2010 estimate is taking into account lower earnings for the remainder of the year at .17 eps. The industry average is over 15 PE, so 7.50 would be a very conservative fare share value for GAME to hold this year. ... Next year earnings estimate is .83 for 2011, and if growth prospects remain promissing, anticpated 30% in 2011."

Game is whack
I agree. To my Foolish eye, the valuation on this stock is totally out of whack with its prospects. I mean, did Shanda scare investors with its March prediction of a 10% to 15% quarterly revenue decline? Sure it did. But that doesn't change the fact that valued on what it has already accomplished, this company is selling for 8.2 times trailing earnings, and 6.2 time free cash flow.

And even if you take the company's warning at face value, the resulting forward P/E on this anticipated 15% long-term grower works out to just 7.4 times earnings, which is a significant discount to the double-digit multiples accorded rivals like Sohu.com (Nasdaq: SOHU) and Giant Interactive (NYSE: GA).

Foolish takeaway
Reviewing the valuation earlier this month, my Foolish colleague and gaming stock fanboy Rick Munarriz pronounced Shanda's valuation "ridiculously cheap." Ridiculous enough to spawn a hilariously big bounce when Shanda announces its Q1 results a couple of weeks from now?

Why, yes. As a matter of fact, I suspect it will be.

But feel free to disagree. If you believe this is more a case of "GAME OVER!" for Shanda, don't be shy -- tell us why.