Bottom feeding: Office Depot's stock

FORTUNE -- It's been three hard years for Office Depot. Key markets such as Florida and California got hammered in the downturn. It's lost customers to rival Staples. And it was embarrassed by a series of accounting scandals. Since trading at $38 in early 2007, shares have fallen 89% to penny-stock levels.

That's enough bad news for some top managers to bet on a turnaround -- at least for its stock. William Blair's $700-million Small Cap Growth Fund, which posted 7% annual gains to beat 97% of its competitors in the past decade, bought 1.2 million shares in the first quarter. Hedge fund stars Steve Cohen of SAC Capital Advisors and Lee Ainslie of Maverick Capital also added stakes this year.

William Blair's small cap analyst Charles Coustan expects Office Depot to surprise investors with cuts to some of its $1.4 billion of indirect costs, but he says they won't give the retailer credit until it officially makes an announcement.

"This is a stock that doesn't get much respect," he quips. "It's kind of the Rodney Dangerfield of retail stocks."

Office Depot (ODP, Fortune 500) has undertaken a multi-year turnaround plan to improve earnings. In 2009 it cut $680 million of operating expenses, mostly by closing 120 stores. It reduced distribution centers from 33 to 12. And now it's meeting with vendors to review every product it sells.

The recession has been especially hard on the retailer, which gets about 25% of its sales from Florida and California. But even without an economic recovery, Coustan argues, the cost cuts should double Office Depot's expected earnings for 2011. "We're betting on the things that management can control," he says. Indeed, last week Office Depot posted a better-than-expected quarterly loss, driven by cost cuts and profits in its North American stores.

Others say Office Depot could win if the office supply market consolidates in the next five years. It tried to merge with Staples (SPLS, Fortune 500) in 1997, but a judge halted the move on antitrust worries. But if Office Depot were to try and join forces with Office Max (OMX, Fortune 500), a deal may not face as much antitrust scrutiny, and a combination could shutter redundant locations and better operate delivery businesses.

The stock remains risky. Staples has staged a small recovery over the last two quarters: Its same-store sales have risen by 3% and 1%, respectively. But Office Depot's fell by 9% and 1% during the same periods. Joscelyn MacKay, a Morningstar credit analyst, says that's a sign the retailer is losing customers. "Staples has to be winning market share," she says. That could hamper any benefits of its cost-cutting measures.

But others see the stock as a risk worth taking. Coustan also thinks it's a bargain. Because Office Depot's profits are so depressed, it's difficult to use the usual price-to-earnings ratios, but on an enterprise-value-to-sales ratio, he notes that Office Depot is trading near its ten-year low of 0.1 as competitors OfficeMax and Staples trade near long-term averages.

And J.P. Morgan analyst Christopher Horvers, who predicts that shares will to rise to $8 in the next year, wrote in a July note: It's "not the value fishing market right now, but nonetheless a lot of bad news is in this stock." Office Depot is used to bad news. Investors might take advantage of that.