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Treasure and Trash When Dumpster Diving for Stocks

NEW YORK (TheStreet) -- Buying distressed securities is one of the tools in the arsenal of value investors. We sometimes buy stocks that few other investors want: stocks that are downright ugly in many respects. The key here is to identify situations where, no matter how bad the situation may appear, the punishment inflicted on a stock by the market is beyond what is deserved.

This can be a risky game, and it's easy to make mistakes. It's also easy to fall into some bad investment habits. I've certainly made my share of miscues in this area. But when you are right, the rewards can be great.

This type of investing is much easier, for lack of a better word, when the markets are under tremendous stress as they were in 2008 and early 2009. The likes of Gannett (GCI), Saks (now owned by Hudson's Bay (HBC:Toronto)) and many others were priced for bankruptcy, and the rewards of buying those names were great. Others, such as Cabela's (CAB), and eBay (EBAY), were not truly in distress but were priced as though they were in big trouble. The rewards of buying them have been stellar.

It was an irrational market, and those that could get past the seemingly never ending freefall and daily doses of bad news were able to take advantage.

GCI Chart
data by YCharts

It's a much different environment today. The bargains are not plentiful, and there are a whole bunch of value investors who are bored because they can't find much to get excited about. One value manager told me recently that his firm is doing a lot more selling than buying.

Must Read: Feb. 12 Premarket Briefing: 10 Things You Should Know

With so little to be excited about in deep value land, it becomes easier to fall into the traps.

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