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Lovable Losers

Just because a stock is beaten down, reeling, and universally maligned doesn’t mean you shouldn’t buy it. Here, five stinkers that could yield sweet returns.

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We believe in fairy tales on Wall Street, even though we think we are tough guys. Our favorite fairy tale is the story of the ugly duckling—you know, the one that grows up to be the beautiful swan. Every single year on Wall Street, some disgusting, grotesque piece of business transcends its natural ugliness and emerges as something beautiful to behold, and, of course, much better to own.

Last year, Nextel morphed from the hideous to the beautiful. The colossally overlevered phone company flew from barely above sea level to the 52-week-high list and never looked back. I caught that ride for my public portfolio, ActionAlertsPlus.com, and I’m determined to find this year’s Nextel, a stock that can soar in a short time from single-digit midget to $28 worth of stature.

But I am warning you ahead of time. For each Nextel, there are ten ducks that just stay ugly or get lame or get their heads ripped off by foxes out for a good time. To find the next Nextel, you must look at the flock and make determinations that leave you holding a bunch of losers in the hope that one will emerge to wipe away the stench of decay that the others will bring to your portfolio. Consider the math, though: Buying 1,000 Nextel when it was stinking up the joint at, say, $6 as part of a basket of similarly priced uglies gave you a more-than-fourfold return. Given that not all of the others will necessarily go to zero, the next Nextel can make up for a lot of damage.

Where do you find the next Nextels? The usual bedraggled places: broken phone companies and their suppliers, smashed-up Latin American utilities, crushed and given-up-for-dead energy merchants, and, of course, indebted, almost belly-up cable carriers. It’s that salted-over field that must be resown, disgusting and futile as it seems, because that’s exactly the barren ground that spawned Nextel. That’s right, the uglier the better.

No place is uglier than the natural-gas-merchant patch right now. To find a bull on El Paso or Dynegy, my two favorites—and I own all of these—is next to impossible. These stocks are completely hated by all—analysts, institutions, individuals, even state regulators and juries. They destroyed themselves, Enron-style, by taking down huge amounts of debt, buying utilities and power plants, and dominating the “merchant energy” business, which turned out not to be a business at all. Just like Nextel at its bottom.

Both El Paso and Dynegy are losing scads and scads of money—again, very much like Nextel. And both have executive teams that know the Nextel playbook by heart: They are drastically slashing debt and selling assets, and will, in eighteen months, go from bleeding cash to coining it. Because almost nobody thinks this will happen, the stocks are near their lows. However, they have just started climbing as the companies have made it clear that they recognize their sins and are determined to fix their balance sheets no matter what. Don’t worry about having missed the exact bottom. I didn’t get in at the exact bottom of Nextel, either. I waited until I was sure that Nextel couldn’t go belly-up. That was the better time to commit.

That time is now for these two despised securities.

AES should have gone out of business. It made more mistakes than any company in the power business worldwide. But like Nortel when it was below $2, AES was too important to go bankrupt. The Latin American nations where it generates power didn’t want the bankruptcy to tarnish what is one of the most remarkable emerging-market turnarounds in history, one that almost no one has participated in and one that continues apace in 2004. This $9 stock, while having tripled off the bottom, could triple twice and still not get back to anywhere near where it was, even though it is a much better, more solvent company now than at any time in the past four years. Once followed and loved by major analysts, the stock is barely followed by anyone now, and nobody likes it. When they start liking it, I will sell it, but it won’t be anywhere near the single digits it trades at now.

One of the components of catching the next Nextel is that you want to buy it when everybody hates it because the current business conditions are atrocious, while the future has to be brighter if only because the expenses have been ratcheted down since the build-out is nearly completed. That’s why AT&T Wireless and Charter Communications are so right. AT&T Wireless just finished what may turn out to be the worst single quarter any major wireless provider has ever had. Wireless portability was a total fiasco for this company, one of the worst publicity nightmares ever visited on an entity. Which is why every single major analyst who had been recommending the company—five, count them, five analysts—have downgraded it. But here’s the beauty of the downtrodden. Wireless portability occurred at just about the time that AT&T Wireless had almost finished its humongous ramp-up of infrastructure to make the company look and feel like a national provider, one that could be easily swallowed by Cingular or Deutsche Telekom or even France Telecom. When’s the time to pounce? When the company reports, which will be in a few weeks. It will get hammered, perhaps to $7, and you and I will buy all we want because that will be the benchmark of bad quarters and it won’t get any worse. In fact, I expect the business to either turn for the better or the management to turn to a seller in 2004. Two ways to win.

Charter’s harder. It takes great faith to own a company with this much debt and this little credibility—most of its old management team had to be sacked for accounting chicanery. But that hasn’t stopped Adelphia from coming back; its stock doesn’t trade but its bonds have gone up 150 percent in the past year. Nor has it stopped Cablevision, one of the worst-run companies ever, from advancing. Now it is Charter’s turn.

Five stinkers. Five totally hated companies. Five companies that don’t have any friends on the Street. Except for me.

Which is just how I like it. Just like Nextel.

TheStreet.com
Get all of James J. Cramer's stock picks via e-mail, before he makes the trades, by subscribing to Action Alerts Plus. A free two-week trial subscription is available at thestreet.com/aaplus.

James J. Cramer is co-founder of TheStreet.com. At the time of publication, he owned stock in Nextel, El Paso, Dynegy, AES, AT&T Wireless, and Charter Communications. He often buys and sells securities that are the subject of his columns and articles, both before and after they are published, and the positions he takes may change at any time.


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