Beachcombing With the Insiders

It was another bad week for the market as investors continued to focus on economic and valuation worries that we've been highlighting weekly in InsiderInsights.

The poor retail sales figure for May (down 0.9%) apparently caught some pundits by surprise, but the real surprise to us is why anyone expected consumers to continue their torrid spending pace, given the highly indebted state of many consumers. This was one of the reasons we felt strongly about making bets against this market nearly two months ago, going long the Profunds UltraShort Fund and shorting SPDRs. And we are not closing these winning bets yet. Insiders are still flashing very bearish signals on the prospects of the overall market.

Most talking heads don't expect consumer spending stats to continue downward, but they now have to consider the possibility. It is well-known that the U.S. economic turnaround (and therefore, to some extent, the world's economic turnaround) owes quite a lot to U.S. citizens spending like there's no tomorrow. If this spending music stops, there is little else to carry on the tune of recovery.

One more bad month of spending stats will prompt the phrase "double dip" to gush forth in everyone's favorite newspapers, as economists weigh the possibility of dipping into another short recession.

But let us also point out some good news. Although we are prepared for a miserable summer for the stock market overall, we are also prepared to make some opportunistic purchases as pessimism takes good stocks down with the bad ones.

So, far from advising investors to go to cash and head for the beach all summer, we view this current market as an excellent one for beachcombing -- that is, picking up interesting stocks from the flotsam being cast about in this stormy market. (OK, so we're financial writers, not poets.)

Consider Corio

We're beginning to do this with some old recommendations we were previously stopped out of. Our initial recommendation of application service provider Corio worked out extremely well. We picked it at $1.18 in mid-March and saw it trade up to $1.75. When profit-taking and market pessimism started taking it back down, we were stopped out at $1.50, a 27% gain in just over a month.

Being pessimistic about the market, we didn't fall over ourselves to recommend Corio again as it subsequently hovered around $1.25 or even $1.15. But when it falls back below $1.10, like it did a couple of weeks ago, we would suggest picking it up.

We still think this stock is a good long-term bet. Although the company still has quarters to go before its industry will improve enough to offer profits, we believe Corio's business of helping firms cope with the hassles of managing and upgrading enterprise software from the likes of Oracle, PeopleSoft, Siebel Systems(SEBL) and SAP is a valuable one.

Sure, the sales and stock prices of these large software providers are in the tank, but there is a lot of their software already in place. Outsourcing management of their systems to application service providers like Corio is a cost-saving move for many firms.

We also note that after rebounding from the lows it hit after Sept. 11, Corio has found support all year near $1. Given Corio's cash on hand of $1.54 per share as of March 31, it's a little surprising that support isn't higher. But investors recognize that the company will lose more money before returning to profitability, so trading below the latest stated cash per share figure is hardly bizarre.

We also view the company's revenue recognition policy, as explained to us by Chairman George Kadifa, as conservative, and we like that the firm separates both the revenue and expense line items in a straightforward manner. Kadifa further indicates that there may be more room for cost-cutting.

This quarter is not going to be stellar, but that's no surprise. We still expect the firm to end June with about $63 million of cash and short-term investments, which equates to $1.23 per share. And we feel the stock will pay off if business starts to improve in the fourth quarter. If we're wrong, we think the odds are still good we will be able to exit the stock at around what we paid.

Network Equipment

Another stock we think is an excellent opportunistic purchase is Network Equipment. We're sitting on a sizeable loss on this one right now, but we are sticking with it, primarily because the company has cash of over $4 per share. We also believe Network Equipment will be able to return to profitability in the next year.

In one way, at this price the stock has a similar investment thesis to Corio's. Both companies have refocused their product lines as a result of the changed tech environment, and they have also cut costs to reduce their cash drain. Both are also trading near their cash levels. So if and when tech spending does rebound, these two firms should show excellent profits if they have bet correctly on the new focus of their products.

With Network Equipment and Corio trading at or below present cash levels, we think these two are better beachcombing stocks than, say, Vitesse Semiconductor, a stock we wrote about in April that has not been kind to us. Although we view Vitesse as a tech company that has reduced costs and refocused its product line admirably, it still trades for two times the company's present (and declining) cash on hand. Vitesse has been trading poorly, though, and could become attractive flotsam in the near future.

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