Headline Risk: Buzzword for a Neurotic Era

Back in August, Wachovia Securities put a buy rating and $23 price target on Tyco(TYC - Cramer's Take - Stockpickr), whose stock was fetching $12 and change at the time. Sounds like a bargain, right? But the analysts warned of a looming threat to the price target: "headline risk."

This shadowy threat lurks as the new investment buzzword, replacing the Panglossian parlance of the late '90s -- New Economy and synergy are punch lines now. A search for "headline risk" on Dow Jones Interactive news confirms the term's status: "Headline risk" first turned up in a 1989 article on the savings and loan debacle, was used once or twice a year during the early 1990s, ticked up to a few dozen times a year in the late '90s and ballooned to 288 times so far in 2002.

But what does it mean? And how should an investor factor it into a stock's price? A few authoritative sources declined to answer the first question. "We don't have an official definition, but it's a thorny one that we will most likely add," said Nick Philipson, executive editor of the tome Business: The Ultimate Resource, who is working on a business dictionary.

Geoffrey Nunberg, linguistics professor at Stanford and author of The Way We Talk Now, also demurred, saying the term's rise is a response to the number of corporate scandals, as well as growth of the individual investor. "Time was, only the biggest of these stories were front-page news -- when a stock in your portfolio tanked, you didn't find out about it till you got your statement."

Until Webster's weighs in, we're stuck with my dime-store definition: waiting for the other shoe to drop. Headline risk-plagued companies have dropped the ball on either an ethical or operational basis, and the fear of more bad news is putting a lid on the stock. That leads us to the more important second question: How should investors incorporate headline risk into stock evaluation?

When the risks are greatly amplified, fortune favors the brave. Legg Mason Focus Trust manager Robert Hagstrom calls headline risk "one of the few opportunities for investors to find mispricings in the extreme." Let's examine a few companies with big headline risks to determine the potential for rewards.