The Manual of I...'s  Instablog

The major U.S. stock indices are roughly flat year-to-date as of this writing, but it has not felt that way. The worldwide market turbulence has carried echoes of 2008, and some companies’ stock prices have been decimated. In this report, we look at twenty equities that have suffered major price declines this year. The group includes former highfliers that seemed destined to conquer the world only a few years ago but are now headed for doom, at least according to short-sellers and some analysts. Yet, many of the naysayers now that the stocks trade at single-digit earnings multiples were cheerleaders when those equities were selling for double-digit sales multiples or triple-digit earnings multiples.

One such company is First Solar (Nasdaq: FSLR), which we highlight as a top idea this month. First Solar could seemingly do no wrong before the downturn. The stock price hit $300 per share, a market value of $24 billion, in 2008, a year in which the company had sales of $1.2 billion and net income of $350 million. Revenue and income roughly doubled by 2010 and should be not too dissimilar in 2011, yet the stock has been cut to under $50 per share, a market value of $4 billion.

First Solar’s recently revised EPS guidance of $6.50-7.50 in 2011 compares favorably to the stock price. What’s more the shares trade only ~10% above tangible book value, with no net debt on the balance sheet. As a result, even if profitability declines further while the industry works through the current glut of capacity, the downside should be reasonably protected.

The key might be whether First Solar’s “thin film” technology really is superior to traditional crystalline silicon solar technology, as the company and analysts have long claimed. This appears to be the case, at least for the time being. The company is focused on continuing to lower cost toward grid parity. Achieving this goal will be crucial as government incentives are phased out due to sovereign fiscal woes.

The example of Netflix (Nasdaq: NFLX; not profiled in this issue) also reflects Wall Street’s ability to go from exuberance to despondency in a short time. Value investor Whitney Tilson sold short Netflix in the past couple of years, suffering big losses as the shares continued their momentum-driven rise. Tilson finally threw in the towel when the stock catapulted to over $200 per share. The subsequent rally took Netflix to over $300 per share in July of this year. One earnings disappointment later, and Netflix is back to under $80 per share at the time of this writing. Tilson now views the stock as cheap enough to justify a long position.

All of the companies analyzed in this issue have fared terribly this year in terms of stock price performance, and investor sentiment reflects this fact. Investors generally sound smarter when they discuss the poor near-term business outlook as justification for passing on a stock or selling it short, often with little regard to the relationship between price and intrinsic value. On the other hand, it is much harder to sound smart when advocating the purchase of a company that trades at a single-digit earnings multiple or a discount to tangible book value while the fundamental outlook is cloudy. One is easily dismissed as naïve: “Don’t you know how bad things will get for the industry/company due to overcapacity, price competition, regulation, etc?” — ”Yes, but the price more than compensates for these risks.” This is a perfectly fine answer, but the contrarian uttering it can be easily dismissed as ignorant of the risks. Ultimately, however, the investor who accurately assesses the gap between price and value should be vindicated. By the time this occurs, the analysts and pundits will have moved on to another smart-sounding theory, with no one typically calling them on their previous blunders.

Table of contents:

The Manual of Ideas, November 2011
— The Fear Issue (105 pages)

Editorial Commentary — John Mihaljevic highlights six investment ideas
Superinvestor Update — Tracking the portfolio moves of top investors
Exclusive Interview with Tom Gayner — Revisiting March '09 interview
20 "Fearful" Investment Candidates — Analyzing large YTD price losers
Favorite Value-oriented Screens — Ideas for bargain-hunting investors
This Month's Top 10 Web Links — A selection of third-party resources
Extra: Valuation Scenarios — Test sensitivity to key assumptions

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