The Next Big Bargain

The market offers bargain opportunities every day. You won't always know what the opportunity will be, but finding one can supercharge your portfolio.

Master investor Peter Lynch said that one advantage of running Fidelity Magellan (FMAGX) was its charter. It was a capital appreciation fund, giving Lynch the flexibility to buy in any investment situation. Big or small, constant or cyclical growth, asset plays or turnarounds -- you name it, Lynch bought it.

While we should follow his example and look for the best opportunities in any form -- growth stories, turnarounds, misunderstood stocks-- one type of investment can be particularly rewarding.

Limited-time-only sales
The best companies grow steadily year after year, right? Wrong. Great companies have plenty of miscues along the way, but the truly great companies recover.

If the initial step on the road to great returns is to invest in great companies, we must first know what it takes to be great. Read Built to Last or Good to Great by Jim Collins. Read Common Stocks, Uncommon Profits by super-investor Philip Fisher. Another master, Warren Buffett, offers his thoughts in his annual chairman's letters. Read those, too. Trust me -- you'll learn what makes a company great.

We'd all be rich if investors simply had to identify great companies. The second key, as Buffett advocates, is to buy them when they're on sale. And when do they go on sale? When there are problems.

At Inside Value, we know it's difficult to purchase companies surrounded by negativity. But the market offers the opportunity for big rewards -- provided those problems are only temporary. Here are some recent examples of great companies selling at discount prices for a limited time:

Data provided by Capital IQ, a division of Standard & Poor's.
Returns as of July 2, 2008.

30% off
2004 started off as a good year for Hewlett-Packard. In 2003, the company was restructuring to become more cost-competitive with Dell, beating earnings and regaining favor in the process.

Despite raising guidance for 2004, several patent-infringement lawsuits, as well as continued price erosion on computer hardware, created enough uncertainty to cause some investors to sell.

Fortunately, a strong printer business and effective cost-cutting helped the company beat estimates in August 2004, sending the stock higher. It also didn't hurt that the company doubled its share-buyback program to $2 billion.

50% off
It should be no surprise that hard-disk maker Western Digital's fortunes would closely follow those of the computer industry. But it is a coincidence that HP and Western Digital's lows occurred on the same day?

What drove Western Digital's stock price down? Revenue growth lagged unit growth. It's never comforting to lack pricing power, even as the level of technology is increasing. But such is the nature of this difficult industry, where Western Digital was up against competitors like Seagate Technology (NYSE:STX).

But still, at its low, the company was trading at an enterprise value-to-EBITDA ratio of just greater than four, a historical low for a company with a pretty good balance sheet and a history of growth.

95% off
The Enron collapse took down many energy giants, including Calpine, Dynegy (NYSE:DYN), AES, Reliant (NYSE:RRI), and El Paso. All of them watched their stock prices drop 90% from all-time highs.

Calpine's problem lay in overpaying for its generation assets, then not being able to produce meaningful returns from them. Yeah, value destruction.

Don't get me wrong: El Paso had plenty of troubles of its own, including overstating its natural gas reserves, manipulating natural gas markets, restating its financial statements, declining credit ratings, a large debt burden, and class action lawsuits. However, despite the issues, El Paso's assets continued to generate cash flow. Value creation.

Today, Calpine is trying to emerge from bankruptcy. El Paso? It's still getting back on track. But fire-sale buyers who bought El Paso near the bottom are up more than 500%!

Today's sales
Within the market, there are plenty of underappreciated, unloved, and misunderstood businesses. Add the right catalyst, and you've got opportunity.

Despite the difficulties Legg Mason (NYSE:LM) has faced over the past 6 months, Motley Fool Inside Value likes the franchise.

Legg Mason, despite capital support agreements it has entered into to support its money market funds, is a collection of wonderful asset managers. Sure, there have been outflows of capital, but investors are fickle, especially during difficult times like these.

Will the bad times last forever? Richard Grubman of Highfields Capital Management and Marty Whitman of Third Avenue Value don't think so. As Legg Mason's stock price has been falling, they've been buying -- in large chunks. Apparently, Inside Value lead analyst Philip Durell isn't the only one who thinks the stock offers a great opportunity.

On sale tomorrow ...
What will be tomorrow's big bargain? That's what Durell and his Inside Value team dedicate themselves to finding. If you'd like to take a look at the stocks we're recommending today, click here to join our community free for 30 days. There is no obligation to subscribe.

This article was originally published on June 24, 2005. It has been updated.

Million Dollar Portfolio Associate Advisor David Meier owns shares of AES, but he does not own shares in any of the other companies mentioned. The Motley Fool owns shares of Legg Mason. Dell is an Inside Value pick. The Motley Fool has a disclosure policy.