Stocks That Rise From Downgrades

A source of superb ideas for value investors is in companies that are getting downgraded en masse by Wall Street analysts. Consider, for example, leading hospital provider HCA (HCA - commentary - Cramer's Take). From early October of last year to January of this year, the company was hit with eight consecutive rating downgrades by analysts. There was not a single buy recommendation.

HCA stock traded in the mid- to high-$30s during this onslaught of negativity. After the fifth consecutive downgrade, on Oct. 19 of last year, the stock traded at its 52-week low of $34.70. Today, though, just a few months after this series of downgrades, HCA is up more than 50% to its current level of over $53 per share.

Despite having one of the most impressive retail models around, CarMax (KMX - commentary - Cramer's Take) endured four consecutive analyst downgrades from mid-August to October of 2004. Since then, the stock has jumped more than 40%, from about $20 per share to over $28.

Over the last couple of years, Boeing (BA - commentary - Cramer's Take) shares have climbed more than 100% from its lows at $25 per share to its current value of $59. Yet fewer than one in three analyst reports in that time period have been bullish.

Why do companies like HCA, CarMax, Boeing and others increase in value after a raft of analyst negativity? Here are a few of the reasons:

Analysts have a linear bias. The linear bias of analysts is evident during both good and bad times. When a company is enjoying good times, say, by growing earnings by 15% over a prior year, analysts typically project a similar level of growth into the distant future. And when companies such as HCA, CarMax and Boeing run into problems, as they did, they are projected to struggle for protracted periods of time. All businesses are cyclical and inconsistent. Good and bad times run in cycles. Bargain-hunters can take advantage of negativity by buying during periods of maximum pessimism.

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At time of publication, Alsin and/or Alsin Capital Management was long Boeing, CarMax, Eastman Kodak and AON, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail].