Back in August, Wachovia Securities put a buy rating and $23 price target on

Tyco

(TYC)

, 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.

Tyco

The Headline Risk:

Tyco, WorldCom and Enron made up the Big Three of accounting-fraud disasters of the past 18 months. Two companies are now penny stocks, but debate rages over Tyco's value. There will be no shortage of negative headlines swirling around Tyco in the coming months as we enter the latter portion of the crime-and-punishment drama of former CFO Mark Swartz and former CEO Dennis Kozlowski -- including possible new revelations about the company's books from Swartz.

The company also faces major debt concerns, weakness at its electronics business (which makes up about 28% of sales) and a host of other nagging issues. "Any reasonably prudent investor would not be long Tyco's stock,"

RealMoney.com

columnist Arne Alsin said. "If I can't rely on the books, I can't invest."

The Headline Reward:

Tyco's stock -- since tumbling to a 52-week low of $6.98 in July, just before Ed Breen assumed the CEO post -- has surged 134% to $16.34. Some well-regarded money managers, such as Bill Miller and Robert Hagstrom of Legg Mason and John C. Thompson of Thompson Plumb Growth, have bought shares in recent months, and they say the stock still has plenty of room to rise. "This is a stock with a $25 to $30 breakup value --

after

accounting for debt," says Thompson, who started buying before Breen came on board. Even Alsin says the company's stock is worth in the low $20s if the books are clean. The conglomerate has reasonable businesses, but uncertainty about the legitimacy of its accounting -- especially how Tyco handled its scores of acquisitions -- makes any reckoning tricky. A conservative assessment of the company's separate businesses -- again,

if

the books can be trusted -- puts Tyco's worth at $22. That's a 34% difference from its recent stock price -- a nice gain, if it materializes.

The Other Shoe:

Get past the slew of ugly headlines and focus on the two things that could stop the Tyco turnaround story dead in its tracks: debt and accounting. First, debt: Tyco has more than $11 billion in debt obligations maturing between now and the end of 2003. The company has taken some steps to lighten the load, including the recent sale of CIT, but it is now dependent on the kindness of its lenders, including three big banks who are owed $3.9 billion come February (for more on Tyco's debt troubles, read Peter Eavis' excellent

cautionary tale). Some Tyco watchers say the banks are showing a willingness to extend loans to the new management. If the banks take a hard line with Tyco, demanding collateral upfront, it's a signal that they don't like the company's prospects -- meaning trouble ahead for Tyco. The second possible shoe is accounting: Given Tyco's aggressive accounting for its acquisitions, in addition to Kozlowski & Co.'s proven disregard for accounting standards, it seems likely that more restatements are coming. Restatements of past results will matter if they hinder Tyco's future in one of two ways: a big cut in 2003 earnings projections (analysts expect $1.58 a share for the year, the company expects between $1.50 and $1.75) or if they trigger a major debt-financing problem.

The Bottom Line:

Investors who want to take a chance on Tyco should be ready to sell if one of the two shoes mentioned above falls. Also, if the stock continues to rise quickly -- to, say, $21 or $22 before the debt and accounting issues are resolved -- the safe move would be to get out with your 35% return while the getting's good.

AOL Time Warner

The Headline Risk:

You've got problems!

AOL Time Warner

(AOL)

has lots of them. Some sleazy "round-trip" deals that

may result in restatements. The likelihood of another multibillion-dollar writedown of goodwill, this time at its AOL division. A battle to oust Chairman Steve Case, the last man standing from the days when those sleazy deals went down, meaning he was "asleep at the wheel or crooked; either way, it's not good," says Thompson. An online division with an entire subset of problems: a moribund ad market, problems pushing into broadband, mounting concerns about eroding cash flow in 2003 and, frighteningly,

Microsoft

as its rival. The company's fortunes, meanwhile, are tethered to the prospects of an economic recovery, a variable entirely out of the company's hands.

The Headline Reward:

Even with AOL's stock climbing 70% to just under $15 from its 52-week low of $8.70 in July, the market is still assigning a negative value to AOL's Internet operations. Many analysts and money managers believe Time Warner's media properties alone are worth $15 to $18 a share. The online operation, even with its problems, has more than 35.3 million dial-up subscribers paying $20 or so a month, plus about 500,000 broadband subscribers -- Time Warner's Road Runner has 2.3 million broadband subscribers (behind

Comcast

). It's facing fierce competition in both dial-up and broadband, but, as Thompson says, "I am confident in the laziness of the average person; people aren't all going to go through the hassle of switching." Also, the likely write-off, which will make for big headlines, is unlikely to affect the company's debt covenants. If Steve Case goes (more big headlines), that will most likely give the stock a boost -- even if he takes the Internet business with him in a spinoff. AOL bulls see the stock heading to $25; conservatively, assigning a $3 value on AOL (the real value may be closer to $4 or $5), it is worth at least $18, or 20% above current levels.

The Other Shoe:

There are a few possibilities here, including a major restatement of revenue and earnings or a major shortfall or warning on 2003 cash flow. The market was relieved in October that the $190 million restatement wasn't larger. The company says it doesn't expect any more; another sizable restatement would cause a lot of believers to lose faith. If AOL itself doesn't let the other shoe drop with a big warning or restatement, the next-best sign might be Standard & Poor's, which has the company's debt on CreditWatch for a possible downgrade. The agency's next move -- reaffirm or cut -- may have big implications.

The Bottom Line:

The picture on AOL is likely to clear up, either way, by year-end. For those willing to take a risk, the company still looks like a decent bet. Worst-case scenario: If two shoes -- big restatement and an earnings warning -- drop, Time Warner's assets offer downside protection.

Citigroup

The Headline Risk:

The "You've Got Mail!" line could apply to

Citigroup's

(C) - Get Report

headline-risk woes these days -- it seems like every morning the dailies offer up another juicy email that paints Citigroup in an unflattering light. Sandy Weill, one of the few remaining non-tech celebrity CEOs still at the helm, has gone from master builder to albatross. The "headline-risk" issues swirling around Citigroup -- regulatory scrutiny, conflicts of interest over analysts, "Nursery-gate" -- make ever-narrowing concentric circles around Weill himself.

The Headline Reward:

Most likely, aside from a one-off charge and some residual damage to its securities business, Citigroup's bottom line isn't in grave danger from the current matters; indeed, the majority of its business comes from consumers, not Wall Street. The stock has climbed 40% to $37.72 from the Oct. 9 close of $26.89, including a solid rise Wednesday after UBS Warburg offered a sum-of-the-parts analysis of the company that gave a $50 stock target for Citigroup. It looks increasingly likely that Weill will

vacate the house that he built, taking much of the headline risk with him. Using Warburg's current fair value of Citigroup -- $44, excluding headline risk (yep, they used the term, too) -- the stock is 17% undervalued.

The Other Shoe:

The biggest threat to Citigroup -- which sports a P/E of 11.4, below the industry's 12.7 average even though it has posted better growth -- is the economy itself. If the economy slides back into recession, and many of its consumer-oriented businesses weaken, it could lead to less borrowing and higher default levels.

The Bottom Line:

Citigroup may be the safest bet of the three headline-risk stocks discussed; as a result, the reward potential is the smallest.