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 the farthest. 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 Thursday and Friday last week. 52-week high, recent price, and CAPS ratings from Motley Fool CAPS.

Knock, knock
Who's there? If you ask most CAPS members, it's Opportunity with a capital "O." With the possible exception of Sunpower -- whose prospects remain overcast by continuing pessimism in the solar sector -- CAPS members believe each of these hard-hit stocks may be about to turn the corner. They're bound to bounce back, and when they do, fearless Fools today are poised to reap the rewards tomorrow.

Who will bounce highest? Our 145,000 (and growing) lay equity analysts see the most potential in a little-known tech shop by the name of Investment Technology Group (ITG). But what makes it so special?

The bull case for Investment Technology Group 
CAPS member jfjf88 introduced us to ITG way back in 2006 as a company specializing in: 

... trading software (especially trade execution performance tracking). It also maintains a quasi-exchange, POSIT, where traders can cross large blocks of shares anonymously. Operating margins are typically in the high 20s. Excellent software and POSIT make ITG an excellent acquisition candidate in the technology-driven consolidation of exchanges.

jerseytix calls this a "great business model," with "great numbers."

Meanwhile, All-Star investor and all-around good Fool TMFJake suggests that the key thing to look for at ITG is "increasing margins in their international markets business. This may take some time to play out ..."

Buy the numbers?
Well, it's been 18 months since TMFJake made that prognosis. Let's see how well ITG is performing on its promise.

Alas, ITG's margins are not, in fact, increasing. Its fiscal 2009 earnings report, released last Wednesday, shows operating margins down more than 50% in comparison to fiscal 2008. The international operations, on which TMFJake hung his hopes, produced a net loss for the quarter. In fact, with commission revenue on equity trades down 24% in the fiscal fourth quarter, ITG's profit plunged, missing consensus estimates by more than 20%.

Miserable news? Investors seem to have thought so, sending the stock down 10% on Thursday. But to my Foolish eye, that looks like an overreaction (and I'm not alone in that belief -- the stock rallied Friday, regaining at least some of its lost ground.

Consider: ITG hasn't released its cash flow information for the quarter yet, but based on the 12 months' worth of data we have for the periods preceding earnings, the company generated cash at the rate of more than $210 million per year -- far more than it reported as net income.

Even if you take a worst-case scenario, and value ITG on the average $93 million in annual free cash flow it generated from 2004 through 2008, the stock looks value-priced at an 8.2-times multiple (even cheaper than its 9.7 P/E.) Relative to consensus estimates of 11% for annualized five-year growth, that seems to offer an attractive margin of safety.

Foolish takeaway
Across the investment industry, companies are reporting lower trading volume and strangled profit. It's gotten so bad that Goldman Sachs (NYSE:GS) downgraded the whole sector back in December, cutting price targets on everyone from TD AMERITRADE to E*TRADE (NASDAQ:ETFC) to Schwab (NASDAQ:SCHW).

But pessimism like this can become contagious, and lead investors to sell stocks whose valuation would otherwise dictate a "buy." To me, that seems what we're looking at here with ITG -- a stock flush with $331 million in cash (versus just $47 million in long-term debt), cranking out more cash every day, and seemingly valued as if its trading volumes and profit will decline, never to revive. Personally, I don't think that very likely.

And as soon as investors realize this -- that, Fools, will be the day that ITG bounces back.

(Of course, you are free to disagree. If you believe that Investment Technology Group is doomed to obsolescence, here's your chance to warn the rest of us away from it. Click on over to Motley Fool CAPS now, and sound off.)

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