No one has to make the stock market any more complicated than it really is. That's because, in its purest form, it's just a genuine trading exchange where stock trades hands based on what the consensus believes it's worth.
In other words: Investing is easy. Investors are complicated.
That's why the only thing I relish more than the stock that everyone loves is the one that everyone loves for all the wrong reasons. Why? Because there's potential there. Just like the mint to be made when a guy buys a foreclosed home in shambles, dolls it up, and sells it at a much higher price, there's money to be made in buying stocks that are primed for an eventual makeover.
Now, you've heard value analysts make this argument for decades. Contrarians love to zig when everyone else zags. There's money to be made there, for sure. Otherwise, value guru Philip Durell wouldn't be beating the market with his Inside Value newsletter. However, I think this strategy can be applied to growth stocks, too -- and not just any growth stocks, either. I'm talking about the high-flying ultimate growth equities that have made Rule Breaker investing so popular since David Gardner pioneered the practice in the 1990s.
Bleeding by example
Let me show you what I mean. Last month, I bought shares in Marchex
Anyway, Marchex certainly wouldn't seem to be a company in need of fixing. The stock has shot up nearly 80% since bottoming out in August. Marchex is profitable and, last month, posted a 110% spurt in revenue. The company toils away in the lucrative online advertising market. It owns a few contextual pay-per-click marketing outfits like IndustryBrains and Enhance Interactive.
However, what initially drew me to Marchex was that it owned more than 200,000 traffic-generating domain names. When you see a company like Google
To that end, Marchex is putting some of its domains to good use. It owns the pages of the vast majority of five-digit ZIP codes in the country and, in August, started rolling out localized search pages to cash in on the turf. Try 90210.com to see what I mean. Anyway, that may be the logical monetization fix for its 73,000 ZIP code domains, but Marchex has some other awesome dot-com names, including debts.com and CareerInfo.com.
It has populated them with paid search ads, but that's just the simpleton's model for building vertical sites. I can definitely see the day when the company either builds out these destinations into more marketable destinations that will generate even more ad revenue or simply borrow from the about.com model and outsource some of its domains to other content creators in exchange for a piece of the action.
Anyway, if you want to know why I bought Marchex, it's because one of its biggest domains is hardware-update.com. It may not exactly roll off the tongue, but it was a site that Microsoft
However, if you go there, you'll see that the sponsored listings have little to do with Windows operating system problems, computer upgrades, or attractive peripherals. No, most of the ads in the main body of the page are for replacement windows for the home. Talk about a blown opportunity. I have no idea how poorly targeted the other Marchex properties may be, but although this might be indicative, my excitement is still there. It's an easy fix, and it represents untapped profit potential that will come around once the company wakes up from its shortcomings.
Broken but willing to mend
The key is to find a quality company where either the problem or the solution isn't evident to the mainstream market as a whole. When I singled out XM Satellite Radio
However, when it comes time to step on the market scale, it's Sirius that is commanding the larger market cap. Understanding the problem is easy because the only material developments at Sirius over the past year that would position it ahead of its only satellite radio competitor is the hiring of radio programming guru Mel Karmazin and a $500 million five-year contract with Howard Stern. Since Sirius signed Stern, the stock has appreciated by $5 billion in market value. Not a bad deal, of course.
However, why is the market ignoring XM's position as a force with twice as many subscribers as Sirius? They both charge monthly subscribers the same reasonable sum, so XM's wider base translates into lower programming and acquisition costs than Sirius. If Sirius can afford to pay Stern, why can't XM strike similar deals? Yes, there's only one Howard Stern, but let's not limit the market to Rush Limbaugh, Dr. Laura, Don Imus, Jim Rome, Phil Hendrie, Jerry Springer, Bob and Tom, or any other popular syndicated terrestrial radio mainstays.
The money and growing audiences in satellite radio may be just the ticket to make television stars bolt for XM. I'm not suggesting that Leno or Letterman will be XM-bound once their contracts run out, but they're getting paid a fraction of what Stern will be pulling on Sirius. Connect the dots. Satellite radio is only going to get bigger, and XM will be a welcome beneficiary. Who knows whether it will be a Conan or a Kimmel to cross over first, but it will happen.
Going for the glue gun over the discounted cash flow calculator
Sometimes, a good story can become a great one. And a great story can become even greater. I've been a shareholder of Stock Advisor pick Netflix
The model made too much sense, and the growing subscriber base ultimately vindicated the model that Wall Street had little choice but to agree on. Netflix chugged along nicely until a year ago. That's when the company initiated a pricing war to keep its distant competitors even more distant. The market hated that. It shredded shares of Netflix all the way into the single digits.
Did I bail? No way. The market only saw the problem but without thinking through the obvious solution. Netflix was born lean and had the established subscriber base. There was no way that an upstart was going to be able to compete against Netflix on price. There was also no way that a bricks-and-mortar chain like Blockbuster
So bring on the broken, especially when they also happen to be uber-growth stocks. There, it's not so much a matter of a turnaround as it is a step forward. And a step forward is a good place to be, especially when you can arrive fashionably early before the other growth investors.
Want to see what other mended stocks Rick is liking these days? Take us up on a free trial subscription to Rule Breakers that will allow you to see what all the fuss is about until 2006 comes around.
Longtime Fool contributor Rick Munarriz doesn't mind buying broken merchandise, as long as he can land the manual on how to fix it. He does own shares in Netflix and Marchex preferred. The Fool has a disclosure policy. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.