By Amy Tsao Unlike a lot of fund managers, Mike Corbett of the Perritt Microcap Fund says he's eyeing a feast of investment opportunities these days. Sure, he's as happy as anyone that the tech-laden Nasdaq has rebounded 17% off its late-September lows following the terrorist attacks on the World Trade Center and the Pentagon.
Corbett isn't interested in momentum investing, however. He's focused on stocks that trade at under $5 a share and have a market capitalization of less than $500 million. And that universe got a lot bigger in late September. Nasdaq said that stocks trading under $1 a share and/or those not having a required number of shares publicly available to trade would not risk being delisted until at least Jan. 2.
GRANTED A REPRIEVE. Nasdaq's decision to temporarily relax some of its listing requirements is aimed at stabilizing a wobbly market as the war on terrorism rages. But for bargain hunters like Corbett, the move has put dozens of former highfliers on his radar screen. So he and many other Wall Street pros are sifting through the low-fliers in hopes of finding a few with long-term prospects.
The risks in this part of the market are significant. "If there's nothing substantive there, a little time is not going to help them," says Sally Anderson, a senior portfolio manager at Kopp Growth Fund. If listing requirements are enforced once again in January as planned, many companies now down on their luck will likely close up shop later rather than sooner. Still, Corbett estimates that about half the exchange's 4,300 traded companies meet his investing criteria -- and it's unlikely that 50% of the exchange's companies will go belly up next year.
"There were a lot of tech companies created from this boom, but they used to be too expensive," he says. "Now I can buy them at reasonable prices." Corbett sticks to some basic criteria when hunting out bargain stocks. Besides liquidity, he looks for companies with little or no debt, a good cash position, and recurring revenues.
"BELOW CASH VALUE". "I'm trying to find the ones that have really interesting stories and ideas in terms of what their business can evolve into," Corbett says. One example: ScanSoft (SSFT), which makes software for desktop scanners. The stock trades around $2 per share. Helped by a 25% increase in sales, the company recently reported a third-quarter net income of $3.6 million, or 6 cents per share, vs. a net loss in the same period one year ago.
Pat Adams, portfolio manager at Denver-based Choice Funds in Denver, takes a similar view of some of the market dregs. "There's a lot of stocks that have been punished to an extent that surprises me," he says. "They're trading near or below cash value. Some of these companies were darlings of a year or two ago."
Networking systems company Redback Networks (RBAK) is one he's watching. The stock is trading around $3 a share, down from a 52-week high of $167. Redback's new router, which was unveiled recently, is generating some excitement. For now, the dismal economic environment promises to be a challenge for the company and its peers, but Adams is hopeful the stock could reach the $10 level in 12 to 18 months, when companies return to higher levels of tech spending.
PROGNOSIS: PROFITS. Redback's not the only one. As shares of networking giant Cisco (CSCO), one of the biggest names in technology, trade around $14 each, many smaller network-equipment companies are much cheaper, and some of them will thrive when the economic recovery materializes. A good portion of the companies that Jay Ritter, Morningstar's network-equipment analyst, covers have fallen below the $3 level. Of those fallen stars, he says, "Redback and Sonus Networks (SONS) were two considered to have bright prospects."
Since the share prices are so low, Ritter doesn't actively cover either stock anymore, but he says both could stage a comeback. "The problem is the downturn they're in is likely to drag on for a while. It becomes an issue of how long they can survive -- it's a balance-sheet question." At the end of their September quarters, Redback had $246 million in cash while Sonus, which recently pushed above $4 per share, had $137 million in cash.
Dan Veru, vice-president at Palisade Capital, a money-management firm in Fort Lee, N.J., also likes the cheapie stocks, but he says the trick is keeping an eye on valuation rather than price. "A lot of these companies are down-and-out. But that doesn't mean some won't recover. Some of our best investments have been lower-priced issues that were down-and-out for whatever reasons," he says.
TELECOM CALLING. He cites rural radio-station company Regent Communications (RGCI), which is trading around $6 per share, or at a price-to-earnings ratio of 9. "There are excellent prospects there once advertising dollars start to come in," he says.
Mike Hodel, telecom analyst at Morningstar, says two companies tied to Verizon (VZ) could make it through the ongoing telecom slowdown. Flag Telecom (FTHL), which trades around $1, has a joint-venture relationship with Verizon in which Flag provides the phone service company with networks for its international services. Verizon owns a large stake of common shares of the company, and it doesn't have the debt problems that afflict similar companies.
Then there's Web-hosting and e-business network provider Genuity Inc. (GENU), which trades under $2 per share. It has a deal with Verizon, in which the company has the option to take control of Genuity. "They have a shot at being viable over the long term because of that relationship," Hodel says.
TEMPTATION AND RISK. Make no mistake -- the risks associated with investing in stocks this cheap can't be underestimated. While more than a handful of companies should benefit from the temporary suspension of listing requirements, the majority likely won't. And many of the industries to which these companies belong -- telecommunications gear and e-commerce, to name two -- continue to struggle through a deep slump that could get worse before improving.
Investors should never infer that just because a company still trades, it has viable long-term prospects. "Most are selling down there because their business is failing," says Annette Geddes, managing directors at Sass Investors Services. In fact, in many cases, these companies' woes predate September 11. But for investors with the inclination to look, hope is blooming that there are diamonds to be be found amid the debris. Tsao covers financial markets for BusinessWeek Online in New York