Markets

Seven Bargain Stocks

Unknown and unloved, these stocks hold the potential for big gains.

By David Landis, Contributing Editor

Jeffrey R. Kosnett, Senior Editor

From Kiplinger's Personal Finance magazine, November 2006

CEO Harvey Berger makes no such prediction, but says legal fees and stock-option expenses made this year's results -- a stream of losses -- worse than expected. Berger says he's satisfied with the progress in the labs and with the trials. Because most new drugs get knocked out earlier in the process, optimism over 573 seems warranted.

Living in fat city

Darling International deals in matters that aren't usually the subject of cocktail-party conversation. But its business also comes with a sexy side that could fuel interest in Darling's stock. The Irving, Tex., company, founded in 1882, collects and recycles animal byproducts, such as fat and bones, from grocers, butchers and restaurants. It then sells its finished products, such as tallow and "yellow grease," to makers of soaps, pet foods and livestock feed. Darling says it is the largest independent processor of animal byproducts in the U.S. and the only public company in the business.

Rendering and grease refining are not exactly high-growth businesses, but here's the newsy part of the story: Darling is considering entering the biofuels business, at least on a small scale, because it could turn its grease into cheap fuel (see "Profiting in Biofuels," on page 66). Plus, Darling's profit margins could improve significantly because prices are rising for some types of products it sells, and the costs of natural gas (used in the recycling process) and diesel fuel (used to truck materials to Darling's widely scattered plants) are falling. In addition, Darling bought one of its chief rivals earlier this year.

A few institutional investors control most of Darling's shares, a situation that dates to 2002, when lenders agreed to swap debt for equity. The stock, now more than $4, was then worth about $1. So, despite the absence of much analyst research and Darling's unremarkable business, the stock has performed well. Now, company officials, including CEO Randall Stuewe, say Darling is getting the attention of a wider group of would-be shareholders. That bodes well for the stock.

Election-year special

Shares of Gray Television, which owns 36 stations in 30 U.S. markets, sank 30% in the first eight and a half months of 2006, and analysts expect earnings to plunge close to 50% in 2007. Hardly seems like the makings of a winner.

Yet there are compelling reasons to consider Gray's shares. First, thanks to political ads, TV stations normally clean up in the second half of even-numbered years. More than 70% of Gray's revenues come from local advertising, including political buys. Even better, Gray stations are situated in seven state capitals and more than a dozen major university towns, where politics is presumably a major sport. So earnings in the third and fourth quarters of 2006 could be better than expected. Of course, this being election season is hardly a secret, so you could argue that all those ad revenues are already baked into the stock, which recently fetched a bit less than $7.

But the market isn't always right, especially when it comes to small, overlooked companies. Gray's shares are still extraordinarily cheap. Analyst Michael Buckley of the media-research firm Kagan Research says TV stations are measured on the basis of cash flow (earnings plus depreciation and other noncash charges) from operations. Gray's stock, he says, trades at about 4.5 times the last four quarters of operating cash flow. But Buckley says that private-equity investors (those who buy entire companies) are paying 10 to 11 times cash flow for small-market TV stations and as much as 17 times cash flow for large-market stations.

By this yardstick, Gray appears to own undervalued assets, although the firm carries a lot of debt. Says president Bob Prather: "Wall Street has just written off the television industry. We'll have to prove 'em wrong."

Fund choices: Three that own the tiniest firms

There's no simple way to invest in a mutual fund that owns low-priced stocks. Yes, there is Fidelity Low-Priced Stock, but that fund buys stocks for up to $35 a share -- and it's closed to new investors. So is Royce Low-Priced Stock. If you prefer stocks with single-digit prices, an alternative is to invest in a fund that focuses on micro caps. Micro-cap stocks -- those with minuscule market values -- do not necessarily carry low share prices. But both micro caps and low-priced companies tend to be tiny.

Perritt Emerging Opportunities (symbol PREOX; 800-332-3133) buys companies with market values of less than $250 million. The fund returned a solid 15% in 2005, its first full year of operations, and 7% in the first eight months of 2006. Expenses of 2.2% are high, but they should drop as the fund grows.

Bridgeway Ultra-Small Company Market (BRSIX; 800-661-3550) takes an index-like approach, with a portfolio of more than 700 stocks. Lead manager John Montgomery has an excellent reputation for holding down expenses (0.73% annually). The fund is having a sluggish '06, up 3% to September 1, but it returned an annualized 22% over five years.

An exchange-traded fund, iShares Russell Microcap Index (IWC), is an even-lower-cost option (0.6%). The year-old fund tracks a special version of the Russell Microcap index that kicks out companies with shares that trade too infrequently. It gained 5% this year.

The companies listed below share single-digit prices but otherwise differ greatly, with annual sales ranging from $4 million to $11 billion. Another thing they have in common: All of the stocks are risky.

Data to September 18. *Based on 2007 estimated earnings. **For the last four quarters. #Based on the fiscal year ending August 31. NM not meaningful. N/A Not applicable. Sources: Thomson Financial, Yahoo.

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