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6 Tantalizing Stocks Investors Are Too Scared to Buy

By Anand Chokkavelu, CFA - Updated Apr 6, 2017 at 11:46AM

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They may present opportunities for the brave.

Something needs to be wrong.

That's what I tell house hunters in the Washington, D.C., area, where The Motley Fool's offices are located.

Thanks to a relatively stable local economy with a fairly low 6% unemployment rate, housing prices here can still provide some post-bubble sticker shock. But savvy homebuyers find deals by looking for traits that discourage other potential buyers. Whereas others see problems in terms like "fixer-upper," "short sale," or "nine months on the market," the savvy see opportunity.

As writer Charles R. Swindoll put it, "We are all faced with a series of great opportunities brilliantly disguised as impossible situations."

The current stock market is analogous. It's down from previous heights, but you can still get burned overpaying for the stock that "shows well."

An example of the kind of stock we're looking for
To be clear, subtlety isn't rewarded in bargain hunting. We want situations with huge glaring problems that scare the dickens out of investors. In short, we want a situation like Tempur-Pedic (NYSE: TPX) 16 months ago.

During an economywide liquidity crisis, Tempur-Pedic had a net debt-to-equity ratio of almost 6:1. Even in normal circumstances, red flags usually start going up at 1:1. Worse, it made premium mattresses priced well into the thousands. Swedish TEMPUR material or not, a worsening economy had a very real chance of wiping out a highly leveraged company that peddled high-end furniture to a populace losing more sleep over the possibility of foreclosure than the threat of a gimpy back.

Tempur-Pedic's problems were as subtle as a late-night infomercial, and investors pushed its stock price down from highs in the upper $30's to a low of $3.84.

However, the situation was never as dire as the reaction. Yes, Tempur-Pedic faced real problems, and the chances of bankruptcy were present. But even at its low point, it had positive earnings (barely) and solid, if unspectacular, free cash flows. And it was still a premium brand name in the mattress industry.

If it survived, the upside would be orders of magnitude greater than its downside. And that's exactly what happened. As overall market fears subsided, Tempur-Pedic rocketed from $3.84 back into the $30s, where it stands today.

Today's Tempur-Pedics
Tempur-Pedic may still have some upside left at today's prices, but general investor confidence is much higher, Tempur-Pedic's net-debt-to-equity ratio has fallen closer to 3:1, and its profitability has strengthened.

While investors are no longer cowering at the sight of Tempur-Pedic's ticker, here are six stocks the market's doubting now:

Company

Fall from peak*

The fear

Transocean (NYSE: RIG)

68%

It's a deepwater driller in a deepwater-unfriendly world.

Gannett (NYSE: GCI)

86%

Newspapers are dead.

Sirius XM (Nasdaq: SIRI)

63%

Excessive debt combined with a threatened business model.

E*Trade (NYSE: ETFC)

77%

A toxic balance sheet.

Melco Crown (Nasdaq: MPEL)

76%

Oversupply due to fierce competition.

FormFactor (Nasdaq: FORM)

76%

Permanent impairment of profitability in a wildly cyclical industry.

Source: Capital IQ (a Standard & Poor's company).
*Figures based on market capitalization.

Let me explain what you have to believe to buy these stocks.

Transocean's Deepwater Horizon rig was involved in the BP oil spill. The catastrophe dropped Transocean's stock from around $90 to its current price in the low $50's. Those who believe Transocean's liability in the incident will be minor, and that fears for the deepwater industry worldwide (most of Transocean's $11.6 billion in sales are outside the U.S.) are overblown, will want to look into this company.

My fellow Fool Morgan Housel highlighted USA TODAY publisher Gannett as "the best company in an absolutely terrible industry (newspapers)." Enough said.

A bull on Sirius XM would have to believe that it can handle its debt load by increasing its 19.5 million subscriber count profitably (partially by reducing churn), continuing to lower its cost structure, and increasing its current $11.48 average monthly revenue per subscriber.

E*TRADE's earnings have been battered by write-offs on the toxic assets it collected during the housing bubble. This is clearly a "How bad is the balance sheet?" situation.

Melco Crown runs casinos in Macau -- the "it" destination for Chinese gamblers. Macau surpassed Las Vegas to become the world's largest gambling center back in 2006. Investors mostly fear oversupply by Melco and its competitors. For Melco to be a buy, gambling demand has to outstrip the temptation to oversupply.

FormFactor makes testing equipment for the semiconductor industry. The industry as a whole has been on a rollercoaster ride, and FormFactor has suffered painful losses and a management shakeup recently. However, the company boasts 80% of its market capitalization in cash. In other words, if the stock is trading at $10, you're really getting its business operations for $2.

A final thought
It's possible that none of these stocks will follow Tempur-Pedic's comeback track -- they all do have serious problems. But these are the kinds of situations that reward brave investors who can perform careful analysis and practice patient contrarianism.

Let's discuss in the comments section below.

Anand Chokkavelu owns shares of Tempur-Pedic, Transocean, Sirius, Melco Crown, and Form Factor. Melco Crown Entertainment is a Motley Fool Global Gainspick. Motley Fool Options has recommended a bull call spread position on FormFactor, which is a Motley Fool Hidden Gemsrecommendation. The Fool owns shares of FormFactor. The Fool has a disclosure policy.

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Stocks Mentioned

Tempur Sealy International, Inc. Stock Quote
Tempur Sealy International, Inc.
TPX
$28.94 (0.35%) $0.10
Sirius XM Holdings Inc. Stock Quote
Sirius XM Holdings Inc.
SIRI
$6.49 (-0.46%) $0.03
Gannett Co., Inc. Stock Quote
Gannett Co., Inc.
GCI
Transocean Ltd. Stock Quote
Transocean Ltd.
RIG
$3.82 (8.83%) $0.31
Melco Crown Entertainment Limited Stock Quote
Melco Crown Entertainment Limited
MLCO
$5.63 (1.81%) $0.10
FormFactor, Inc. Stock Quote
FormFactor, Inc.
FORM
$34.33 (2.63%) $0.88

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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