NEW YORK (CNN/MONEY) -
No one can predict the future with much accuracy. To the extent that stock analysis is a science, it consists of sizing up a company's numbers, and weighing ratios based on consensus estimates against historical patterns.
But sometimes the market behaves in unprecedented ways, at least for a while. And sometimes a company runs into unexpected problems, and all the consensus numbers turn out to be wrong.
What should shareholders do when a company suffers such a shock? If the risk exposure looks open-ended, there's a case for selling right away and cutting your losses. But if the problems can be quickly contained, you could end up selling at the bottom.
During the past year, I've recommended two stocks -- Washington Mutual and Boston Scientific -- that have been slammed recently. In both cases, I think well-diversified investors should consider hanging on.
Riding out the storm
Washington Mutual is a Seattle-based savings and loan that grew to be the seventh-largest U.S. bank, largely on the strength of its mortgage business. Given the booming housing market and low interest rates, WaMu was able to crank out compound earnings growth of more than 18 percent a year.
In addition, the company was an active acquirer, buying 10 major lenders including Great Western and Dime Bancorp.
Nonetheless, Washington Mutual was unprepared for the inevitable upturn in interest rates. Refinancings slowed, and earnings began to deteriorate in last year's fourth quarter. Still, it wasn't evident until now just how exposed the company is to rising interest rates.
In part, the problem is that WaMu still gets a disproportionate 60 percent of its business from mortgages. Also, the company failed to hedge adequately against the widely expected upturn in interest rates.
And those problems were exacerbated by the fact that WaMu had trouble keeping track of its financial position because of incompatible software systems from all its acquisitions.
Nonetheless, many of these vulnerabilities have long been recognized by investors -- Washington Mutual (WM: Research, Estimates) was always a cheap stock. Moreover, the damage to profits seems to be done and the company's long-term franchise still looks undervalued, if you don't mind holding for three to five years.
Even with this year's earnings likely to be down by 24 percent, at $38.55 the stock trades at only 12 times those depressed results. Meanwhile, the shares offer a double-digit growth rate and pay a 4.5 percent yield.
Boston Scientific is the classic story of a high-tech medical stock that is overdependent on a hot product. The company has been flying high on its new drug-coated stent, a wire mesh tube that helps hold open damaged blood vessels.
Last month, the company had to recall more than 86,000 stents after reports that 43 patients had been injured and three had died, possibly because of problems that arose during the insertion of the stents (the problems do not affect patients with stents already in place).
It appears that Boston Scientific has successfully redesigned the stent assembly to eliminate potential problems, and some of the hospitals that had stopped employing the company's stents have resumed using them.
Much of Boston Scientific's long-term success is riding on these products. If there were additional reports of problems with these stents, the stock would likely be hurt even worse. But so far, it appears that the problem has been contained.
Apart from the recall, results for the second quarter were very strong. And several analysts believe the worst is over for the company. If that's true, Boston Scientific (BSX: Research, Estimates) stock is clearly undervalued. With a projected earnings growth rate of nearly 20 percent, the $37.44 stock trades at only 16 times next year's projected earnings.
In the end, there are three conclusions one can draw about such situations. First, they're always a surprise, so although you can sometimes identify a potential risk, there's really is no way to anticipate the magnitude of the damage. Second, the crucial decision to make is whether you think the problem is easily containable.
And third, in the end your only protection is to diversify your portfolio as broadly as possible. Then if a company looks oversold after such a problem, you'll be able to hang on and wait for the shares to come back.
Michael Sivy is an editor-at-large for MONEY magazine. The Sivy on Stocks column and newsletter is available only to MONEY subscribers and AOL members. Click here to subscribe to MONEY and to sign-up for the Sivy newsletter.
|
