In today's market, the majority of companies fall into one a few categories. First and foremost in the news are the financials, which are writing down over-inflated assets from previous "Gain on Sale " Accounting. That accounting is otherwise known as cocaine accounting, because it gave them short-term earnings boosts and the delayed crashes which have been exemplified by Bear Stearns, Merrill (MER), and Lehman (LEH), just to name a few.
The second major category includes most companies which are pessimistic on their growth prospects and are lowering future guidance because of the economic repercussions of the housing market crash. Such companies comprise the bulk of America's large-cap companies and include common technology names such as Cisco (NASDAQ:CSCO) and Dell (NASDAQ:DELL). The third category, of which I find extremely pleasing, are companies which are growing and raising quarterly revenue and earnings estimates. There are few companies in this latter category and they are truly "la crème de la crème" in today's market.
3Com (COMS) is one such company in this latter category. On August 5th, 3Com raised its quarterly earnings estimate from $0.03 to $0.06 a share. It has also had an upside earnings surprise the past 4 quarters, with an average of 75% above the analyst estimates. Yet, the stock trades at a bargain price of just $2.01 a share, or a Forward P/E of 7, and a mere 0.84x Book and 0.65x Sales. In fact, to put this in perspective, last weekend's Barron's streetwise highlights the average S&P 500 companies have a price to sales ratio of: 1.2 with a price of 3x Book and forward P/E of 15.
3Com just announced major news late-day Friday with large contract wins in the Asia Pacific region. It is this kind of growth that makes 3Com my top pick in terms of undervalued stocks. The earnings report is expected around Sept 22nd. By then, the stock price may very well move above $3, which is 25% below the current fair value of $4 a share derived by 3Com's management. Downside risk in today's volatile market is about 10% with upside reward of more than 100%. That may be why 3Com is still very mush a potential takeover candidate.
The question that every wise investor must ask him or herself is "In today's market, what kind of company do I want to hold?" If you are the type that is holding on to a company in the first two categories above (i.e. Financials or downward guiders), then I feel your pain. The good news is that there is an easy cure- flock to a company in the third category such as 3Com. Then, get ready for a lot of alpha.
Disclosure: Long COMS.