Don't Sell This Stock. Ever.

Legendary investor Philip Fisher bought a little radio company called Motorola in 1955 and pioneered a revolution. The guy did his homework, exercised a good deal of discipline, and found himself with a stock that multiplied many, many times -- all while sitting on his rear.

Sounds pretty nice, eh?

In today's volatile and troubled markets, taking your hands off the wheel is probably the last thing you want to do. And just like you, I fight that same fear. But that's precisely what you should be considering it right now. Today may just be the single best time to find a great company, invest in it, and then sit on your butt -- instead of fretting, trading, and losing sleep.

Good story, but how?
I've written before about the decision to chuck your stocks into the wastebasket. But that advice may not be entirely helpful -- what you really need is to avoid the kinds of stocks that put you in that situation in the first place. After all, if you're in a situation where you have to sell a stock because it has problems, it's too late.

To get around that problem, you need to get to know a man buried in an obscure cemetery in the Kreuzberg section of Berlin, Germany.

Man muss invertiren, immer invertiren
In case your German is a bit rusty, the expression translates to "One must invert, always invert." It's credited to the mathematician Carl Gustav Jacob Jacobi, who taught us to make a habit of reversing difficult equations to arrive at the solutions behind them.

Let's take Jacobi's idea and apply it to our current situation.

Instead of thinking about when to sell, perhaps the more intelligent question to ask is the inverted one: When should we never sell? The answer leads us to the "sit on your butt" philosophy that has worked so well for many of history's finest investors.

If we can identify a few businesses that investors should have never sold, we can work backward to extract a few salient characteristics and then use them in our search for the next never-sell investment.

History's lessons
Case No. 1: Berkshire Hathaway
Overall return, 1964-2008: 362,000%
Lesson: Top-flight management

Of all of the advantages that Berkshire Hathaway has going for it, the most obvious begins with two men: Warren Buffett and Charlie Munger. Without them, Berkshire would probably be a now-defunct textile mill. With them, it's been an absolute powerhouse of a company, investing in greats like Wal-Mart (NYSE: WMT) … which goes to show: We should absolutely demand fantastic management.

Case No. 2: Walt Disney (NYSE: DIS)
Return, 1969-present (including dividends): 8,000%
Lesson: Undeniable consumer-facing trends

You may not love cartoons, but I'm willing to bet that a good deal of the young people around you do. The genius of Disney is that it was able to capture and monetize the imagination of children throughout the globe. That's an undeniable consumer trend that Disney actually created and will likely be around for a long-time to come. The lesson? We definitely want a business that appeals to consumers' most basic interests.

Case No. 3: Cisco (Nasdaq: CSCO)
Return, 1990-present (including dividends): 27,300%
Lesson: Agility

Not all companies need to innovate to be great, but the vast majority need to be able to read the market, react, and be ahead of long-term trends. Cisco has had to adapt to a shifting marketplace numerous times and especially throughout the collapse of the dot-coms. The company is definitely agile. I'd venture to say that Southwest Airlines (NYSE: LUV) demonstrates a similar ability to react to market changes and adapt. Let's invest with companies that can zig and zag when others have cement feet.

Case No. 4: Google (Nasdaq: GOOG)
Return since going public in 2004: 337%
Lesson: Scalability

We want businesses that can take on new customers without needing to seriously build out their existing operations. Google is a perfect example, as are other software manufacturers like Microsoft (Nasdaq: MSFT). Reinvestment is costly -- so identify businesses that don't require much of it to scale up the top line.

If you combine these four qualities and find a few stocks that fit the mold, you're probably onto something seriously good. I'd argue it's most likely a company to buy early, buy often, and never sell.

So what now?
We can do two things with this information:

1. Use it as a further tool to understand what stocks we need to sell now. (Talk about inverting!)
2. Use these principles to buy stocks that we'll never, ever need to sell. That's where sitting on our butts comes in.

It's not mere coincidence that most of the world's best investments fall within one of these four categories (many of them share more than one). Nor is it a coincidence that great investors constantly search for these combinations -- as you should, too.

We employ a similar philosophy at The Motley Fool's Stock Advisor service. And it's worked for us thus far: Since our service's inception in 2002, we're beating the market by more than 40 percentage points. The market is in serious turmoil these days, but you can lay the foundation of future financial success today with a few smart investments. Click here for a free 30-day trial of our service. It's risk-free.

Stock Advisor analyst Nick Kapur often tries to invert while snowboarding -- but he generally winds up just sitting on his butt. He owns shares of Walt Disney and Microsoft. Walt Disney and Berkshire are Stock Advisor recommendations. Google is a Rule Breakers recommendation. Berkshire, Wal-Mart, and Microsoft are Inside Value selections. The Fool owns shares of Berkshire Hathaway and has a full disclosure policy.

 

Gambling's Not-So-Great Expectations

What do you get when you combine diminished expectations with soft financial results?

If you're an investor in International Game Technology (NYSE: IGT), you get a booming stock price, up 13% Thursday on nearly double the average daily volume. The reason: IGT's earnings per share of $0.22 for the March-June quarter beat the Wall Street consensus forecast by $0.04.

Once you stop applauding -- the stock was easing back a bit on Friday -- check the numbers for the large slot-machine developer. The consensus earnings forecast for IGT's third quarter was the lowest quarterly prediction in more than six years.

Those third-quarter results were worse than the year-ago quarter, as net income fell to $66.3 million from $108.3 million, while revenue dropped 23% to $522.1 million.

And when the CEO uses a phrase like "an environment of suppressed demand," you might ask: "What's all the cheering about?"

Making changes
Some cheering owes to IGT's stock nearly tripling since it hit an intraday low of $6.81 on March 9. If you've held the stock for a year, you're still in the red.

Others are cheering IGT's efforts to strengthen its financial foundation. In recent months, IGT has completed a popular issuance of convertible notes and amended a $1.7 billion credit facility.

And still others cheer because IGT is reducing operating expenses. Its cost-cutting campaign includes trimming payroll and improving manufacturing efficiency.

Forecasting changes
There's also encouraging news that isn't reflected in the quarter. Some state legislatures are turning to expanded gambling for more funds. Slot machines and video poker terminals are high on the list.

Ohio just gave the OK to add slot machines at racetracks, and it will let voters decide in November whether or not to allow casinos in four large cities. Illinois has a new law enabling bars and restaurants to install video poker terminals.

IGT sees an expanding market, but it must wrestle with companies like WMS Industries (NYSE: WMS) and Bally Technologies (NYSE: BYI) for a share of the action.

The recession will eventually end, and the gambling industry will rebound to an unknown degree at an uncertain pace. Gambling technology companies should be in the forefront, because their products are used not only by casinos but also by racetracks and state lotteries. As for IGT, sell-side analysts are divided between "buys" and "holds," with a few "sells" tossed in.

A disciplined gambler sets a limit on wins and losses. A disciplined investor should treat IGT the same way. If you bought IGT when it fell to single-digit lows in March or November, you've more than doubled your money. Remember the CEO's comments about "suppressed demand?" Maybe this isn't the time to double down.

How These Great Investors Bounced Back Strong

2008's terrible performance for stocks took its toll even among the best investors in the world. But those who ran for the hills following those bad results now have reason to regret their decisions, as many of those experienced money managers have seen market-beating, double-digit returns so far this year.

For a long time during the bear market, many were questioning whether the exceptional track records exemplified by renowned value investors like Bill Miller were merely the result of luck rather than skill. Years of subpar performance made some wonder if they had lost their touch.

Clawing back
But as 2009 has shown, many well-known value managers have started generating market-beating returns once again. Here's a sample:

Fund	Manager	2008 Return	2009 YTD Return
Legg Mason Value Trust (LMNVX)	Bill Miller	(54.6%)	24.4%
Oakmark Select (OAKLX)	Bill Nygren	(36.2%)	27.1%
Muhlenkamp Fund (MUHLX)	Ron Muhlenkamp	(40.4%)	15.5%
Third Avenue Value (TAVFX)	Marty Whitman	(45.6%)	25.5%

Source: Morningstar.

Of course, the gains these fund managers have put up still leave their funds' shareholders in a deep hole after their losses in previous years. Most of these funds posted losses in 2007 as well as 2008. But considering that the recent four-month rally has only brought the S&P 500 to single-digit percentage gains for the year, the much bigger returns that these funds have generated during 2009 have to come as a welcome consolation prize for battered investors.

What went right
Clearly, all of these managers made big mistakes in the past few years. Some of their errors came from underestimating the risks involved in some beaten-down stocks, especially financials. Although it was tempting to believe that traditional value stocks would rebound the same way that they had in the past, the numerous failures in the financial and auto industries, as well as difficulties throughout the economy, have put pressure on investing strategies that had produced much better returns in the past.

Now, though, it appears that these managers can argue that they were merely early on some of their calls. Take a closer look at some of the reasons why these value funds have bounced back so strongly this year.

• Bill Miller has seen his shares of Goldman Sachs (NYSE: GS) almost double so far in 2009, with Amazon.com (Nasdaq: AMZN) and Sears Holdings (Nasdaq: SHLD) also contributing strongly to its performance.
• Bill Nygren's concentration on media stocks like Discovery Communications (Nasdaq: DISCA) have reaped generous returns.
• Ron Muhlenkamp owns a somewhat more eclectic selection of stocks, which has produced winners ranging from offshore-driller Transocean (NYSE: RIG) to medical technology manufacturer Kinetic Concepts (NYSE: KCI).
• Marty Whitman holds a significant amount of assets in foreign stocks. POSCO (NYSE: PKX), for instance, is up 30% this year and has more than doubled from its March lows.

Given what had happened to these stocks' share prices, you can see that many of them would have looked really scary during 2008's panic or the following lows just a few months ago. Yet these managers stuck to their resolve, having confidence in their stock-picking abilities and knowing that in the long run, stocks with strong value propositions along with margins of safety would recover strongly and come back into favor.

Sticking with experience
Even when you have long-time successful managers at the helm of your funds, it's never easy to stick with them when they're having slumps. But what the recovery has reminded us is that great long-term performance comes despite occasional losses. Even though a manager may not make money all the time, great investors have the knowledge and skills to bounce back from even the worst setbacks and sustain that superior track record for years to come.

 

5 Deathbed Stocks?

We've all heard of the "death rattle," the last gasp from a lost soul's lungs. Sometimes, we seem to hear it from the companies in which we invest. Revenues dry up. Margins contract. Profits evaporate. All of these signs suggest that their condition is worsening -- a financial death rattle, if you will.

Stocks in sick bay
Don't assume that all such companies are goners. Some will barely cling to life, while others will make a full recovery. But here we're seeking companies that have all but given up the ghost.

For help, we'll turn to the clever coroners at our 135,000-strong Motley Fool CAPS community, where members give the thumbs-up or thumbs-down to some 5,300 stocks. We've unearthed a handful of stocks that look like they might be headed six feet under based on their one-star ratings, but we'll head over to CAPS to measure our members' opinions on a company's prospects. Then we'll palpate the pulses of those companies with some quick tests for liquidity.

The current ratio and quick ratio, also called the "acid test" ratio, give us an idea of a company's ability to pay its bills, and the Altman Z-Score suggests companies in danger of bankruptcy. Companies scoring 3.00 and above are considered safe, while those scoring between 2.70 and 2.99 are "yellow flags," Those landing between 1.80 and 2.70 have a good chance of going bankrupt within two years, and those with scores below 1.80 mean the cryptkeeper is waiting.

Here's today's list.

Stock	CAPS Rating (Out of 5)	Current Ratio	Acid-Test Ratio	Altman Z-Score	Recent Price
Alto Palermo (Nasdaq: APSA)	*	0.7	0.5	N/A	$5.97
Cott (NYSE: COT)	*	1.2	0.7	2.39	$7.10
MTR Gaming Group (Nasdaq: MNTG)	*	0.5	0.3	1.12	$3.64
New York Times (NYSE: NYT)	*	0.7	0.3	1.42	$6.50
United Airlines (Nasdaq: UAUA)	*	0.7	0.4	0.21	$3.44

Sources: Motley Fool CAPS; Capital IQ, a division of Standard & Poor's.

We obviously can't say for certain that these companies are headed for the graveyard, so don't short them based on their appearance here. Moreover, some companies, such as like software makers and financials, don't neatly fit into the Altman Z-Score scale. Yet like the mythological figure of Charon conducting souls across the River Styx to the netherworld, we'll use the CAPS community as our guide to determine whether these stocks are destined to seriously underperform the market.

Whistling past the graveyard
The move by United Airlines to force some travel agents to foot the bill for credit card processing fees is either a slick, cost-cutting maneuver like those that helped it realize a profit in the latest quarter, or it's an indicator of desperation that could precede its demise.

While the American Society of Travel Agents says its members drove $69 billion worth of business to airlines in 2008, the airlines typically have to pay about 2%-3% of the cost of a ticket for the card processing fees. As airlines battle for survival in this recession and corporate travel budgets are slashed, passing along fees to travel agents seems like an easy way to cut costs. However, agents fear it as a way to force customers to book flights using United's own ticketing system, rather than those offered by global distribution service companies. Southwest Airlines (NYSE: LUV) is one airline that maintains exceptional control over its ticketing process by directing purchases almost solely to its website, but other airlines have not said that they have plans to adopt similar moves.

The cost-shifting might save United money, but it has an added benefit -- it does an end-run around current legal agreements. Under United's new system, travel agents might become liable for the airline's inability to perform, since agents are no longer just intermediaries but rather vendors. If United were to go bust, the agents would become unsecured creditors of the carrier, with little ability to recover the money they had already paid it. This could be a last-ditch move by an airline that analysts currently rate as the second most likely candidate, behind US Airways (NYSE: LCC), to go under.

CAPS member MOSCapital doesn't see much to get excited about, despite the recent cost-cutting ventures:

United Air Lines is a company which at $4.39 is trading at 23 times earnings in a terrible industry. It has negative cash flow, negative earnings, negative return on investment, negative return on equity, negative return on assets, negative profit margins, negative cash return, and about a million different other things that are negative. ...

Bottom Line: A horrible industry combined with more loss years than not and a horrible just about everything else, makes this a no brainer no investment.

Bill Miller, who heads up Legg Mason's (NYSE: LM) Value Trust mutual fund, was once thought to be an investing mastermind. Heading into 2006, Miller had an amazing 15-year streak of beating the performance of the S&P 500 index -- which at the time ranked right up there for me with Takeru Kobayashi's six-year run winning Nathan's Hot Dog Eating Contest.

However, the financial crisis brought that to a screeching halt as major investments in financial companies such as Citigroup (NYSE: C), Countrywide Financial, and Freddie Mac torched the Value Trust's portfolio.

Miller has handily outperformed the S&P so far this year and is preaching up a bullish storm in his recent market commentary. Should we bother listening?

Don't listen to him!
As has been said in the past, some of Miller's outstanding 15-year streak stemmed from the year-end timing lining up well for him. Timing or not, though, there's no mistaking the fact that over the past one, five, and 10 years, Miller's Value Trust has underperformed the S&P 500. On an absolute basis, the fund has produced losses for investors over all of those time periods.

Was he lucky? It sure seems like a real possibility. Many academics and investing experts readily dismiss Warren Buffett's amazing success as a very long, very unlikely streak of luck, so should we allow Miller anything more?

Besides, it's not like Miller suddenly got bullish -- after Bear Stearns collapsed, he claimed "the worst is behind us," and back in January, before stocks had bottomed out, he quipped "this too shall pass."

Listen to him!
Did you really think I was going to bury Miller that quickly? Given his lackluster performance over the past decade, I'm not sure that Miller makes the top of my "investor superheroes" list. However, the Value Trust has produced annualized returns of almost 11.4% since Miller took over in 1990, versus closer to 5% for the S&P over that period, so he's obviously done something right. Besides, even if Miller's bullish conclusion is wrong, he may bring some useful insights to the table.

Miller begins his commentary by sharing that "the preponderance of the evidence supports the view that the worst has passed in the market and the economy." He notes that the economy appears to have vastly slowed its decline, if not stabilized, by the end of the second quarter. He also points to the fact that economists have been raising their growth expectations, and many now expect growth in the second half of the year.

From an equity market perspective, he highlights the fact that the "extreme risk aversion" that we saw late last year and early this year has disappeared. This has already resulted in a jump in the equity markets, but Miller believes there is a lot of money sitting on the sidelines in money market funds that may start moving back into the stock market.

What I found most interesting about Miller's remarks, though, was some research he cited from GaveKal Research about the rhythm of comments during recessions and subsequent recoveries. Miller says:

The psychological cycle goes something like this: first it is said the fiscal and monetary stimuli are not sufficient and won't work. When the markets start up and the economic forecasts begin to be revised up -- where we are now -- the refrain is that it is only an inventory restocking and once it is over the economy will stall or we may even have a double dip. Once the economy begins to improve, the worry is that profits will not recover enough to justify stock prices. When profits recover, it is said that the recovery will be jobless; and when the jobs start being created, the fear is that this will not be sustained.

Basically this would be that classic "wall of worry" that stock markets seem to love climbing over.

Where he's put his money
If there's one thing that you have to respect, it's that Miller most definitely has his (fund's) money where his mouth his. As he's preaching economic recovery, he's got darn near 70% of his fund invested in technology, financials, and consumer discretionary stocks -- three sectors that are most at risk of going splat if we don't get traction on a recovery path.

Miller is known for an exceedingly low turnover rate in his fund, and longtime holdings such as eBay (Nasdaq: EBAY) and Amazon.com (Nasdaq: AMZN) continue to occupy top spots in his portfolio. He's also found some new names that he likes over the past year, and has been cranking up the Value Trust's ownership stake in State Street (NYSE: STT), CME Group (NYSE: CME), and Microsoft (Nasdaq: MSFT).

7 Stocks on Wall Street's Buy List

We all want the best in life, whether it's the best clothes, the best cars, the best houses, or the best stocks. 

One way to find the best stocks is to look for companies that multiple analysts have picked to outperform. It's the analysts' job to rate companies based on their fundamentals, outlook, and valuation, so if several analysts have a buy rating on a particular stock, that might just mean it's a winner.

Take snack and beverage giant PepsiCo (NYSE: PEP) or construction company Fluor (NYSE: FLR), which have outperform calls from 19 and 16 Wall Street analysts , respectively, according to Motley Fool CAPS. Check under the hood of these analyst ratings and you do indeed find strong companies.

PepsiCo remains a solid company despite the brutal recession. Revenue for the maker of Gatorade, Pepsi and Frito Lay declined 3% year over year in the second quarter mostly because of currency translation. In constant currency, sales were up 5.5% for the quarter. The company's international exposure helped support profits, enabling Pepsi to counteract weakness in the U.S. Margins beat expectations across all business units, and the company reaffirmed its full-year outlook.

The recession isn't getting in the way of Pepsi's focus on investing now for a better future. Pepsi has made an offer for its bottlers in an effort to better control costs, only to be rebuffed. Analysts, though, say Pepsi will come back with higher offers. Stay tuned.

Fluor, an engineering and construction management company, is making deals. Just this month the company secured a contract with the U.S. Army to help build operating bases in Afghanistan's northern region that could be worth more than $7 billion over five years. That comes on the heels of a $1.5 billion deal with Canada's Imperial Oil's Kearl oil sands project, which involves surface mining and bitumen extraction. It's weathering the recession surprisingly well for a company that operates in the cyclical infrastructure space.

The company has a solid balance sheet. It holds about $2 billion in cash and short-term securities and sports a measly debt load of about $140 million. Fluor is also very efficient with its owners' capital, boasting a return on equity of 30.3% over the past 12 months. Investors can get a better read on the company when it reports earnings on Aug. 10.

As you can tell, analyst ratings can lead to strong stock ideas. Wouldn't it be great to know which companies Wall Street favors the most? To find some of the Street's favorite companies, I used the screening tool at the "wisdom-of-crowds" club we call CAPS. I screened using the following criteria:

• Stocks with 10 or more outperform ratings from Wall Street analysts.
• Stocks with 1,000 or more outperform ratings from members of the CAPS community.
• Stocks with CAPS ratings of five stars -- the highest possible.
• Stocks with market caps of $5 billion or greater.             

Here are some of the companies that showed up when I ran the screen. (You can view today's version of my screen here.)

Company	Market Cap (in billions)	Outperform Picks	Wall Street Outperforms
Accenture (NYSE: ACN)	$21.0	1,127	15
BP (NYSE: BP)	$155.93	3,020	18
Bristol-Myers Squibb (NYSE: BMY)	$39.84	1,258	17
Colgate-Palmolive (NYSE: CL)	$36.87	1,028	17
Fluor	$9.14	1,153	16
PepsiCo	$87.8	3,568	19
Procter & Gamble (NYSE: PG)	$161.74	6118	20

Source: Motley Fool CAPS.

Keep in mind, though, that while analysts understand equities well, you shouldn't purchase stocks based solely on their buy recommendations. Instead, make their calls an indicator of further research to see whether a particular stock is right for your portfolio.

The New Floor Under Nucor

Did you hear that?

That was your venerable American steel industry striking the water after tumbling from an unfinished bridge.

After hailing Nucor (NYSE: NUE) CEO Dan DiMicco as "a champion for truth in a world full of parroting cheerleaders," I'm relieved to report this straight-talking executive's confirmation that a bottom is in place for the U.S. steel industry.

Nucor recorded a net loss of $133.3 million for the second quarter despite a $125 million credit from LIFO inventory accounting. A 16% decline in realized prices from the first quarter absorbed an 11% uptick in products shipped, and the continued impact of higher-cost pig iron inventories pressured margins further.

Nucor exhibits grace under pressure: refusing to lay off workers as rival U.S. Steel (NYSE: X) has done, paying a 145th consecutive quarterly dividend, and maintaining a $3.5 billion liquidity position that could swallow its entire debt balance whole. As we've seen with smaller competitor AK Steel (NYSE: AKS), quality companies shine when the chips are down, and Nucor makes me reach for my sunglasses.

DiMicco avows that "business conditions bottomed in April," but unlike the bottom called by railroad operator CSX (NYSE: CSX) last week, this call of improving conditions comes complete with supporting data and the overwhelming consensus of competitors from ArcelorMittal (NYSE: MT) to Steel Dynamics (Nasdaq: STLD).

Although Nucor's average steel mill utilization rate increased just a touch, to 46% from 45% in the first quarter, the monthly average plunged to just 38% in April before reversing the downtrend and climbing to 54% in June.

In any major disruption to the balance of supply and demand, movements in either direction tend to overshoot the mark before restriking that balance. Like a diver entering the water, steel orders dipped to an April low before breaking back through the surface for air. Inventories were quite low, leading to a sudden uptick in orders, while the surface of the water (the new balance of supply and real demand) lies somewhere in that 45% to 50% range.

We have a bottom ... now what?
While reporting a $16 million loss for the quarter, Steel Dynamics lamented "conflicting signs in the economy." Nucor's DiMicco offered more color: "We continue to believe that real demand in the steel market is in for a long, slow recovery and there will likely be some bumps along the path." John Ferriola, Nucor's COO, added, "We see little indication that end-use demand has improved and expect no significant improvement for the rest of 2009."

Now that we're finally treading water, it looks as though we're still a long way from dry land.

3 Stocks on Our Radar

In the latest installment of our Motley Fool Money podcast, advisors Seth Jayson, James Early, and Shannon Zimmerman discuss some of the big questions of the week. 

Was anyone really surprised that Microsoft's (Nasdaq: MSFT) earnings were worse than expected? (Really?) With a profitable quarter under its belt, is Ford (NYSE: F) a stock worth test-driving? Is the iPhone becoming Apple's (Nasdaq: AAPL) primary business and, if so, should shareholders be excited or scared? With Chipotle Mexican Grill's (NYSE: CMG) stock doubling since last November, is it too late for investors to get in? And with Amazon (Nasdaq: AMZN) acquiring online retailer Zappos, we dare to ask: Is it just us, or is buying shoes online strictly a woman thing? 

All that, plus hear why McDonald's (NYSE: MCD), Morgan Stanley (NYSE: MS), and Microsoft are the three stocks our panel is eyeing this week. 

3M Keeps Posting Profits

Lately, glimmers of hope that the economy has begun to recover have started popping up more and more. But while 3M (NYSE: MMM) hasn't managed to avoid the effects of the economic recession entirely, the results it announced on Thursday looked pretty impressive to me.

For the quarter, the Minnesota-based company, which makes everything from Scotch tape and Post-it Notes to medical supplies, posted net income of $783 million, or $1.12 per share, compared to $945 million and $1.33 per share during the year-ago period. Backing out special items, the company's EPS came in at $1.20 a share. Analysts, who typically ignore special items in their estimates, had forecast $0.94 per share for the quarter.

Sales also came in weaker than last year, but there were signs that many of the company's six business segments held up reasonably well in the weak economy. The Electro and Communications unit took a big sales hit, as did the Industrial and Transportation segment, especially after accounting for the stronger dollar. At the same time, though, 3M's Health Care unit managed to increase its sales by 2.2% year over year before adjusting for currency translations. Beyond that, both the Consumer and Office segment and the Display and Graphics unit managed to confine their declines to single-digit percentages.

Finding a silver lining
During the conference call following the release, 3M CEO George Buckley emphasized the positives during the quarter, noting that its overall 13% year-over-year fall in sales was a big improvement over the 19.5% sales drop in the first quarter. Moreover, sales improved over 12% sequentially from the previous quarter, and profits were strong in the Health Care and Consumer and Office segments.

Perhaps more importantly, though, 3M certainly isn't alone in facing tough times. United Parcel Service (NYSE: UPS) and Microsoft (Nasdaq: MSFT), both of which reported yesterday, had even weaker quarters than 3M. Even McDonald's (NYSE: MCD) saw its profits decline. My contention from that mix of those companies is that despite some positive housing numbers of late, we likely have a while to go before we see a meaningful economic recovery.

Nevertheless, 3M continues to move along decisively. On Thursday, in addition to its earnings release, the company also announced that it had acquired the ACE product line of bandages and support products from Becton Dickinson (NYSE: BDX). As one not known for dexterity, I suspect I'll end up supplementing 3M's revenues from that segment in the years to come.

In addition to releasing its results, the company favorably narrowed its 2009 profit outlook to between $4.10 and $4.30, from an earlier $3.90 to $4.30. On that basis alone, 3M will stay on my watch list.

Cheap (or Free!) Protection for Your Stocks

Recently, I wrote about a way to insure your portfolio against decline by buying put options -- in effect, insurance policies -- for your largest or most important holdings. Options typically get a bad rap as being risky or speculative, but used correctly to complement a long-term stock portfolio, they're simply tools to help you manage your risk and returns.

So if you want to protect a stock you own, you can buy a put option. But in today's volatile market, it will cost you even more than usual -- about $3,000 to $4,000 to insure the typical $20,000 stock position from now through January 2010. That may be worth it if your stock falls sharply, but it's a lot of money to forfeit if your stock holds steady or increases in price.

There is a way, however, to insure a stock against decline without needing to spend much or any capital yourself. Now that's worth knowing about.

Buying protective puts with call option income (What!? We'll explain)
Let's use Yahoo! (Nasdaq: YHOO) as a general example. Suppose you own 500 shares of the $17 stock, and you want to protect it against further big declines. As of this writing, Yahoo!'s January 2010 put options with a $14 strike price (the price at which you could sell your stock, guaranteed) cost $0.92 per share.

So it will cost you $460 to insure your $8,500 Yahoo! position from now through January 2010, when these options expire. It's expensive, but the insurance would be great to have if Yahoo! falls to $11, as it did in March. No matter what happens, you'll be able to sell your shares at $14 -- but it's a net sell price of $13.08 after factoring in what you paid for the put options.

"But wait," you're saying, "I have to pony up $460 just to insure what is supposed to be an investment? I know times are risky right now, with a lot of uncertainty, but that's a lot to pay for something that very well might not happen!"

It is. And there's an alternative.

Cash in pocket, insurance in hand
Instead, you could pay for much of your insurance by using the proceeds from writing call options on the stock. When you write options, you're the seller of the contract, rather than the buyer, so you're paid up front when you execute the trade. In this case, as the owner of 500 shares of Yahoo!, you could write -- meaning sell -- five call options (each option contract represents 100 shares) on your stock for an immediate payment.

Yahoo!'s $20 January 2010 call options are paying $1.27 per share. You could sell call option contracts on your 500 shares, be paid $635, and then use the money to buy your $14 put contracts for $460. In this case, you actually end up $175 ahead, with cash in your pocket from the call options, while buying puts for insurance.

The catch, however, is that your upside is now limited. If Yahoo! increases above $20 per share and you keep your call options open to expiration, your stock would be called away from you -- in other words, it would be sold for you, at $20 per share. So, even if Yahoo! recovers to $25 or higher, as long as you have these open call options, you'd be forced to sell at $20.

With this strategy, you're insured against a disaster, but you also have limited upside. Therefore, you use this strategy when you're on the defensive, concerned about protecting yourself from potential losses, and don't see tremendous upside in the near term.

When to insure positions with call option income
This option strategy of buying a put and selling a call (or vice versa) is called a "collar" strategy. You're limiting the potential pricing outcome for the position that you're "collaring" -- in this case, Yahoo!. You'll be able to sell it at $14, no matter what.

A collar is a useful tool in bear markets or when you are uncertain about a business. This year, that would have applied to just about any company related to financials, from General Electric (NYSE: GE) to AIG (NYSE: AIG) to Bank of America (NYSE: BAC).

But the strategy can also come in handy with stocks that are volatile at the best of times, especially after making big runs, like to protect a position in Google (Nasdaq: GOOG), Apple (Nasdaq: AAPL), or Baidu (Nasdaq: BIDU).

The strategy may be used when you don't want to sell a stock quite yet, but you also want to limit your potential losses. With a collar, you limit your upside, but you're also in effect saying, "I don't believe there's much upside in the near term anyway. Meanwhile, I'm concerned about the risk. So, I'll insure my stock without any or only a little out-of-pocket expense." The strategy is called a "costless collar."

Options as tools
Options are tools best used in tandem with in-depth business knowledge and a long-term stock perspective. They can be used to protect positions, generate income, short, or hedge, and to get better buy or sell prices on your stocks.

Make These Stocks a Part of Your Portfolio

The dollar is doomed. That was the case Brian Richards and I made not too long ago, and though we thought we'd be the targets of patriotic vitriol, it turns out that a lot of you agreed with us. Color us flattered.

We also gave you some advice in that column on how to protect yourself against a falling dollar: buying companies that do big business in other currencies. This is a list that includes multinationals such as Texas Instruments (NYSE: TXN) as well as foreign corporations such as Taiwan Semiconductor (NYSE: TSM).

Today, however, I'd like to take that advice one step further to tell you my favorite way to get exposure to China specifically -- a country and a currency that are both going to strengthen over the long term at the expense of the United States.

But first, the big picture
One of the people we keep in touch with at Motley Fool Global Gains is a guy named Matt Hayden, whose Hayden Communications specializes in doing investor relations for small Chinese companies.

We've discovered over time that a lot of the companies we find interesting end up being Hayden clients and that Matt also does a pretty good job of giving us the heads-up on other companies we might be interested in. (Note to other IR reps: That's because he doesn't bombard us with info on every company he represents -- only carefully selected ones he thinks we might like.)

Anyway, Matt's out on the road now giving a presentation to shellshocked American investors about why China remains a good long-term opportunity. Here's the short-short version ...

1. Chinese stocks are cheap and get cheaper if you're willing to look at smaller and smaller companies.
According to Matt's data, the average P/E ratio of a NYSE-listed Chinese stock was recently 8.8. The average EV/EBITDA ratio for that stock is 6.2. On the Nasdaq, those ratios are 14.5 and 7.2, respectively, and for the super-small companies trading over the counter, it goes 4.8. and 4.3, respectively.

Given the long-term growth opportunities in China, those numbers all look pretty good to me, but the biggest bargains are to be found at the bottom of the market-cap spectrum.

2. China has upside.
China's GDP is less than one-third that of the United States, despite having four times the population. It also has the lowest debt level (in terms of both government and individual consumers) of any major world economy. That means it has the resources and flexibility to spur further growth -- and one day we should expect the Chinese economy to be as large as or dramatically larger than that of the United States.

3. There are near-term catalysts.
Economic growth in China is not coming to an end. In the near term we should see infrastructure building, the further emergence of a cash-rich middle class, the encouraged consolidation and privatization of state-owned enterprises in order to make the economy more efficient, and the expansion of social welfare programs to spur the spending of some of those citizen savings.

Put these facts together, and you end up with a long-term growth story selling for cheap -- one that also should have some stability amid 2009's economic turmoil.

And that's why analysts at Paribas, Blackrock, Carlyle, and guys like Jim Rogers have been pounding the table for China in their reports.

Here's what I don't want you to do
Now, a lot of folks get these arguments for investing in China and think to themselves, "Yeah, I should have some China." But then they think, "But China's far away, the government is bizarre, and those milk scandals and whatnot have me sketched out about the quality of management." So they either end up doing nothing, or they end up buying an ETF such as the iShares FTSE/Xinhua 25 Index.

If this is you, here's my advice: Do not buy FXI.

There are lots of reasons why we have this opinion at Global Gains, and Todd Wenning does a nice job of summarizing our thinking on this matter in an article called "The Wrong Way to Invest in China." If you don't want to click over, the gist is that FXI is dominated by moribund state-owned companies such as Bank of China and Huaneng Power (NYSE: HNP) that (1) aren't in China's highest-growth sectors and (2) don't really care about the individual American investor.

In other words, buying FXI would have been akin to buying the Dow 30 in the mid-1990s, when you actually wanted to be making a bet on technology companies such as IAC/InterActiveCorp (Nasdaq: IACI), EMC (NYSE: EMC), and Microsoft (Nasdaq: MSFT). Sure, you would have had some exposure, and a rising tide does lift all boats, but the Dow would have been a daft and inefficient way to make this investment.

Here's what I do want you to do
Of course, you're right to think that when you invest in China, you should be diversified. After all, there are enormous execution and other risks in the country that we -- as American investors -- can't 100% solve for.

But rather than buy an ETF, I want you to buy a basket of small, non-state-owned Chinese companies. As you might guess from the data above, these companies are selling for much cheaper than their NYSE-listed, state-owned counterparts, yet they have more upside and are being run more dynamically.

And what I mean by a "basket" is this: You should own five to 10 small, non-SOE Chinese companies that, added together, equal about one or two full positions in your portfolio.

Go out and do it
The best way for American investors to play China for the long term is to create your own diversified basket of small-cap Chinese companies and make these stocks at least a small part of your portfolio today. If you need help filling out that basket, know that our Global Gains team just returned from a research trip to China and will be releasing our top picks from the trip tomorrow to our members in a special report.

Wednesday's Biggest Stock Stars

Hey there, Fools. I've summoned our Motley Fool CAPS community once again to highlight a few of Wednesday's biggest winners among the stocks with top ratings of four or five stars.

Without further ado:

Company	Yesterday's % Gain
ONYX Pharmaceuticals (Nasdaq: ONXX)	21.02%
Linear Technology	8.27%
GigaMedia	6.69%
Seagate Technology (Nasdaq: STX)	5.80%
Dow Chemical	3.76%

There's a reason why I selected those notable gainers as opposed to other winners making noise on Wednesday, like low-rated Starbucks (Nasdaq: SBUX): Stocks go up all the time, but unless you were able to predict the pop, what does it matter?  

Our community of more than 135,000 CAPS Fools considers its high-star stocks the most likely to outperform the market.

Written in the (five) stars?
For example, 89% of the 418 members who've rated Onyx have a bullish opinion of the stock. In late 2007, one of those Fools, skunknumerouno, was already letting Fools in on the biotech's lead star, Nexavar:

Their cancer drug seems to be very versatile and is being reviewed officially for several other types of cancer other than what it was originally intended for. Seems like a great drug to me, waiting for more FDA approvals and higher sales in the next couple of years.

Consistent with that call, shares of Onyx surged over 20% yesterday after a phase 2 trial showed that Nexavar, in addition to its current approvals for liver and kidney cancer, could eventually be used to help treat advanced breast cancer.

The bullish lesson?
There's really no substitute for knowing a company cold. By carefully breaking down the risks and rewards of a given business' pipeline, you'll be well ahead of most investors in estimating what the stock is worth. As CAPS' skunknumerouno understands, Wall Street often fails to discount the massive potential within a company's portfolio, which can add some attractive "optionality" to the valuation.

And now for the losers ...
Of course, winning isn't everything in the stock market.

Here are five of Wednesday's biggest decliners with one- or two-star ratings:   

Company	Yesterday's % Loss
Advanced Micro Devices (NYSE: AMD)	12.99%
Whirlpool	9.92%
UAL (Nasdaq: UAUA)	9.68%
La-Z-Boy	7.91%
Qwest Communications	4.16%

While yesterday's drop in highly-rated Allegheny Tech (NYSE: ATI) may have caught our community off-guard, low-ranked stocks are fully expected to fall hard.

Did CAPS call the fall?
Last month, for instance, CAPS member mrcleaver made a rather simple bear case against AMD: "Not convinced they can compete with Intel (Nasdaq: INTC) with the current pipeline and they're losing money."

Shares of the embattled chip maker are already down 25% since that warning. In fact, yesterday's plunge came after the company posted disappointing sales and margins that were in stark contrast to Intel's strong showing last week.

The bearish takeaway?
Never underestimate the ravages of competition. Having a strong competitive edge is what ultimately drives superior returns on capital, so, more often than not, buying the best puppies, er, stocks is what pays off over time. As Buffett reminds us, "The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage."

The final Foolish move
Investors often focus strictly on stock price movements without realizing that developing a proper stock-picking process counts most.

Over at Motley Fool CAPS, thousands of investors are Foolishly sharing insightful investment tips to help, above all else, identify tomorrow's big movers. Over time, consistently reverse-engineering winning -- and losing -- stocks will help you become a more Foolish investor.

5-Star Stocks Poised to Pop: Ceragon Networks

Based on the aggregated intelligence of 135,000-plus investors participating in Motley Fool CAPS, the Fool's free investing community, Israeli wireless backhaul equipment maker Ceragon Networks (Nasdaq: CRNT) has earned a coveted five-star ranking.

With that in mind, let's take a closer look at Ceragon's business and see what CAPS investors are saying about the stock right now.

Ceragon facts

Headquarters (founded)	Tel Aviv, Israel (1996)
Market Cap	$261 million
Industry	Communications Equipment
TTM Revenue	$214 million
Management	President/CEO Ira Palti CFO Naftali Idan
Compound Annual Revenue Growth (over last five years)	40.7%
Cash/Debt	$76.3 million/$0
Competitors	Alcatel-Lucent (NYSE: ALU) Nokia (NYSE: NOK)
CAPS members bullish on CRNT also bullish on:	Apple (Nasdaq: AAPL) Nuance Communications (Nasdaq: NUAN)
CAPS members bearish on CRNT also bearish on:	Citigroup (NYSE: C) Ford Motor (NYSE: F)

Sources: Capital IQ (a division of Standard & Poor's), and Motley Fool CAPS. TTM = trailing 12 months.

Over on CAPS, 443 of the 446 All-Star members who have rated Ceragon -- some 99% -- believe the stock will outperform the S&P 500 going forward. These bulls include SarahGen and TMFPlatoish, both of whom are ranked in the top 2% of our community.

On Monday, SarahGen kindly (and succinctly) summed up Ceragon's recent quarter: "[T]hey missed on revenue and [earnings per share], but yet the stock is up? It's about the future -- looks better."

In a pitch from late last month, TMFPlatoish helps communicate those prospects:

Ceragon is sitting pretty I think. They make radio systems for wireless backhaul of communications traffic. In places with significant wired infrastructure (fiber and TDM leased line), wireless backhaul is an economical adjunct to facilitate cell splitting and to add additional unplanned capacity necessitated by the explosion of data traffic as smart phones become ubiquitous. ...

Management to shareholder communication is above average for a foreign company and management doesn't shirk from describing problems/issues facing the business. ...

Ceragon is a risky small fish in a big pond. It does have good technology, has continued to grow and operate profitably through the recession, and has plenty of cash and no debt.

Smart Stocks for Penny-Wise Consumers

In a recent speech, National Economic Council Director Larry Summers made some eloquent points about the future of the American financial system:

"The rebuilt American economy must be more export-oriented and less consumption-oriented, more environmentally oriented and less fossil-energy-oriented, more bio- and software-engineering-oriented and less financial-engineering-oriented, more middle-class-oriented and less oriented to income growth that disproportionately favors a very small share of the population."

Dealing with the "less consumption-oriented" part is where things gets tricky. People are saving more, and by the looks of things, they will keep doing that for some time. The savings rate of 6.9% is near its 50-year average, but it's nowhere near the 12% level it reached in the last severe recession in 1982. I believe that the savings rate has a lot higher to climb -- and that many retailers will miss their formerly irresponsible customers.

Yet with a shift in consumer spending habits will come new investing opportunities. So let's examine both sides of the equation.

Retail is vulnerable
As bad the job market is, it's even worse for teens. The nonprofit Employment Policies Institute estimates the teen unemployment rate at 24%, its highest level since 1965. And that's bad news for retailers that cater to the teen demographic.

A case in point is Abercrombie & Fitch (NYSE: ANF). Being in my late 30s, I'm definitely not part of Abercrombie's target audience, but from my vague recollections of visiting its stores years ago, I remember that the clothes are pretty nice and definitely appeal to the teen/college crowd. But the company's recent numbers say it all -- June same-store sales fell at an alarming 32% rate. I remember that prices on Abercrombie's merchandise used to be pretty high. With the savings rate climbing and unemployment likely to rise as well, I just don't see how a company like Abercrombie will see things improve in the next couple of years.

Best Buy (NYSE: BBY) is not as straightforward a case as Abercrombie. It has less competition, thanks to the Circuit City bankruptcy, but its high-priced electronics are especially vulnerable when customers cut their budgets.

Best Buy's first-quarter sales fell by 5% in its domestic stores and 14% internationally, even with Circuit City gone. And according to the Consumer Electronics Association, shipments of electronics in the United States are estimated to fall by 7.7% this year, the first such decline since 2001. On the positive side, shares trade at less than 12 times forward earnings, and Best Buy pays a 1.5% dividend and has a relatively strong balance sheet.

The main question is just how frugal consumers will get. If they give up on big-ticket, high-margin items, then Best Buy and other retailers of high-end products, such as Tiffany (NYSE: TIF), will suffer.

Countertrend retail
We already know that Amazon.com (Nasdaq: AMZN) is thriving, but there are other retailers that benefit from the consumers' frugality. For instance, the trend away from buying new cars has pushed GM and Chrysler into bankruptcy, but buying fewer new cars means doing more repairs on old ones. And if you're a do-it-youselfer, you can save money. This is where AutoZone (NYSE: AZO) steps in.

The company has seen an average annual earnings growth of around 23% over the past decade and currently trades at 12 times forward earnings. It's a good play on the frugality trend. And if my assumptions about higher savings rates and rising unemployment are correct, the company's business is unlikely to stop booming soon.

But some may be concerned that earnings are peaking. For instance, smart-money investor Eddie Lampert recently sold more than 3 million AutoZone shares for a nice gain. But there's nothing wrong with booking profits, and Lampert still controls more than 20 million shares, for a 37% stake in the company. It will be informative to see how much longer Lampert keeps this huge position. I like the stock, but I'd wait for a pullback after its recent run-up.

Worth more than a dollar
Last, dollar stores such as 99 Cents Only Stores (NYSE: NDN) and Family Dollar (NYSE: FDO) have been doing great as a group. As the ultimate frugal choice, it's easy to see why. 99 Cents reported earnings more than twice consensus estimates for the latest quarter. And Family Dollar, although technically not a pure dollar store, also performed well, with a 36% rise in profits on an 8% sales jump. Family Dollar also just raised full-year profit forecasts.

The two companies are clearly at different stages in their business life cycles. 99 Cents trades at an expensive forward price-to-earnings multiple of 23. But its sales are growing rapidly, and with its focus on beleaguered California, the bet is that this will continue. Family Dollar is a bigger company, trading at 13 times forward earnings. It may not have as much room for growth as 99 Cents, but it is better geographically diversified. Take your pick.

While consumers are saving more -- which is a negative for the retail sector in general -- they are also shifting their spending habits. These are just a few ideas of how to profit from that shift.

This Mistake Could Ruin Your Financial Life

Last week, microblogging service Twitter suffered a serious security breach. You could be next.

A hacker used time, sleuthing, and common tools to crack open a Twitter employee's Gmail account and download hundreds of sensitive company documents. Any of us could fall victim to an attack like this, and there's more than embarrassment at stake.

A March report from HSBC Direct (NYSE: HBC) found that 49% of the online population banks via the Web, up roughly 23% in two years. Online banking offers customers greater efficiency and convenience, and all the major financial institutions, including Bank of America (NYSE: BAC), American Express (NYSE: AXP), Citigroup (NYSE: C), and JPMorgan Chase (NYSE: JPM),  have online options. Most of them are secured via proven technology from VeriSign (Nasdaq: VRSN), while others employ the services of digital safekeepers such as VASCO Data Security (Nasdaq: VDSI).

Still, the password that protects your online bank information is only as good as it is difficult to decipher. Make it too easy, and you've got a serious problem. Here are three tips for making a hacker's job harder.

1. Use uncommon words.
The easiest passwords to guess are those that identify with us -- a last name, a child's name, a birthday, the name of a favored pet. Make the hacker's job harder by dabbling in cognitive dissonance, or by using gobbledygook. Have a dog named Frank? Make your password "stalactite," after the cave-dwelling rock formation.

2. Combine unrelated phrases.
Better yet, take "stalactite" and add a word to create a meaningless phrase. (Well, mostly meaningless, since it will be your password.) You can make the process fun by using one of the Web's many random word generators. One I just used returned "squeeze." New password: "stalactitesqueeze." Random. Meaningless. Awesome.

3. Use plenty of symbols.
But maybe not awesome enough. These are just words, after all, and a safecracking computer can bombard a portal with dictionaries of words and phrases until the right combination appears. You're better off adding symbols to your word or phrase of choice: "st@l@ct!te-squ3eze." Harder to guess, right? This still probably isn't perfect, because of the varying loopholes in Web security, but it'll be better than most passwords.

Yes, you should take this personally
Hackers are smart, resourceful, and equipped with a terrific variety of tools for stealing from us. YouTube alone shows 21,900 hits for videos related to "hacked password." There, you'll find plenty here's-how-you-bust-down-a-digital-door tutorials for miscreants. We're far more vulnerable than we'd care to admit.

What can we do about it? Be vigilant. Carefully watch our financial accounts. Balance our checkbooks, track our brokerage transactions, and double-check our credit-card statements every month. Because digital technology, no matter how good it gets, will never be enough to stop the most enterprising hacker. Personal security is still personal.

These 5 Underdogs Are No Dogs

Short-sellers and hedge funds, though sometimes shadowy, are also sometimes seen as the smartest guys in the room. They did their homework and will bet their capital against the crowd. Theirs isn't the most popular way to go, but the rewards can be quite lucrative.

On Motley Fool CAPS, we have our own brand of leading analysts who found the chinks in a company's armor and correctly called its fall. "Underdogs" are investors who earned 100 or more CAPS points correctly predicting that one or more stocks would underperform the market.

Let's look at some of the recent calls these All-Star investors have made. Yet just as hedge-fund operators don't always go short, we're going to look at recent Underdog picks no matter which way the calls were made.

Underdog	Member Rating	Company	CAPS Rating (Out of 5)	Call
caidencollett07	98.98	Eagle Rock Energy Partners (Nasdaq: EROC)	*****	Outperform
HallShadow	99.34	Time Warner (NYSE: TWX)	**	Outperform
kayakmastr	98.18	Innophos Holdings (Nasdaq: IPHS)	*****	Outperform
synergize	99.26	Fuqi International (Nasdaq: FUQI)	***	Outperform
TrackStifel	95.43	Netflix (Nasdaq: NFLX)	**	Outperform

Not every short sale goes as planned, so going short is a risky position to hold. Stock prices can be irrational longer than you have money to stay in the game. So don't use this as a list of stocks to sell or buy, but rather as the launching pad for further research.

Underdogs still wag their tails
It might be true that the death of luxury has arrived, as high-end goods are inevitably less attractive in a recession, and even the wealthiest are now feeling a bit pinched. Yet that hasn't been the case for Fuqi International, a Chinese producer of precious-metal jewelry, which has seen revenue grow at a compounded annual rate of 72% from 2005 through 2008, even though China has felt the recession's effects just as every other country has. Shares of the jewelry maker have quadrupled over the past three months, from around $5 a share to more than $20.

The shares of other jewelry stores haven't done quite so well but are still impressive. Blue Nile (Nasdaq: NILE), an online retailer of diamonds and jewelry, has watched its share price rising by 86% this year. Tiffany (NYSE: TIF) is up 24% year to date.

Yet Fuqi trades at only 10 times projected earnings, compared with Blue Nile's 47 and Tiffany's 16 times earnings. Considering that analysts anticipate five-year growth for Fuqi slightly above 30%, there seems to be no stopping the expansion. China's nouveaux riches have found themselves flush with cash and apparently are willing to spend it on precious jewelry and gold coins.

CAPS member HarrisonW has this to say about Fuqi: "Low P/E with strong sales and earnings growth as retail spending in China will be much better than anywhere in the world with 10,000,000 people expected to marry in China in the next year. Number1 rated in the IBD Top 100 stocks."

While that growth is certainly impressive, it's been aided by acquisitions that will be difficult to sustain. In the first quarter, revenue grew by 41% year over year. That's a good showing by any measure, but it represents a 77% decline in the rate of growth from the prior year's mark. Such a drastic drop could be a red flag, even when we're talking about phenomenal rates. Often, such slowdowns precede an earnings shortfall.

Last month, CAPS member physicsisphun suggested that at around $14 a share, Fuqi was priced too high for many of those same reasons. Yet that didn't stop the stock from pouring it on even more. And this is exactly why shorting stocks can be a dangerous game: The markets can remain irrational longer than you might be able to remain solvent.

i guess I'm *really* against the grain here, but I think this one is overbought. The stock has had a huge run, is no longer cheap in terms of P/E. ... There's currency risk, too. I might change my tune if it drops near 11, since I think it's basically a good company, but not at this price! After a run like this, a lot of folks might run scared if it starts to drop.

Warren Buffett Is a Growth Investor

Berkshire Hathaway's Warren Buffett is a value investor, right? Everyone knows that!

Well don't you tell that to Gerald Martin and John Puthenpurackal of American University and UNLV. In 2008, the two completed what they call "the first rigorous examination of Berkshire Hathaway's investment performance" -- a paper that analyzed not only the superior investment performance of Buffett, but also looked at his investing style.

Besides concluding that Buffett's superior investment returns since 1976 were more than just luck -- as if we didn't know that already! -- Martin and Puthenpurackal concluded that Warren Buffett is ... wait for it ... a large-cap growth investor.

The definition of growth that the researchers used was one that separates value and growth stocks based on the inverse of book value multiples and classifies value stocks as those with the highest book-to-market ratio and pegs those with the lowest as growth stocks. According to the paper, growth stocks accounted for more than 40% of Berkshire's investments, while true value picks made up less than 20% of Buffett's buys.

But let's not get too crazy here. After all, Buffett is still very much a value investor by his own definition -- that is, he only buys stocks that offer a discount to the company's intrinsic value. But what this study does suggest is that if we're looking for Buffett-esque stocks, our best bet is to look for high-quality companies rather than rummage through the bargain bin.

To track down some stocks that might fit the bill, I've enlisted the help of The Motley Fool's CAPS community and its stock screener. I focused my search on stocks that are returning 10% or more on their equity, are trading above book value, and have been highly rated by the CAPS community members. (You can run the same screen by clicking here).

Company	TTM Return on Equity	Book Value Multiple	CAPS Rating (out of 5)
Gilead Sciences (Nasdaq: GILD)	43.7%	9.2	****
Oracle (Nasdaq: ORCL)	22.3%	4.4	****
Amgen (Nasdaq: AMGN)	20.4%	3.0	****
Raytheon (NYSE: RTN)	18.9%	1.9	****
Precision Castparts (NYSE: PCP)	21.5%	2.2	*****

Source: CAPS as of July 22, 2009.

While these aren't meant to be formal recommendations, they're a great place to kick off some research. In fact, why don't we start by taking a closer look at Precision Castparts.

The anatomy of a growth stock
Unless you work at or with the company, are an aerospace enthusiast, or are already an investor (or a member of Motley Fool Stock Advisor, where it's a recommendation), it's unlikely that you've run across Precision Castparts. As its name suggests, the company produces precision castparts -- complex metal structures formed in ceramic molds that go into products like aircraft engines and turbines, artificial hips, and parts for satellite launch vehicles.

Precision sells to a variety of customers; General Electric (NYSE: GE) and United Technologies subsidiary Pratt & Whitney are two of the largest and have each been customers for 30 years or more.

It's not a particularly exciting business and you're unlikely to impress people at a cocktail party by talking about molded metals (and if you do, I'm not sure you're at the right cocktail party). What is exciting though, is the performance of the company. As a dominant player in its niche, Precision has delivered strong top-line growth and has grown operating margins so they're now above 20%.

That's not to say that Precision hasn't hit some tough times with the rest of the market lately. Selling into the industrial and aerospace industries during a recession isn't an enviable position, and it hasn't helped that Boeing (NYSE: BA) seems to have two left feet when it comes to its much-awaited 787 Dreamliner.

CAPS or bust
Considering the rather brutal economic environment, I didn't think that the 13% drop in net income for the company's fiscal first quarter was bad at all. Impressively, the company managed to increase its profit margin from the prior year.

Precision's solid balance sheet is another bullish factor that's hard to overlook, and my fellow Fool Rich Duprey even noted that the Boeing false start may have created an opportunity on stocks like Precision.

I decided to give Precision a thumbs-up in my CAPS portfolio, and I'm far from alone -- nearly 1,300 other CAPS members have rated the stock an outperformer. CAPS All-Star TSIF joined the bullish chorus back in May, writing:

Precision Castparts Corp. continues to show that you can be in an industry that is affected by a recession, and if you are well managed and have a nice moat, you can still come out ahead. By specializing in complex components and special orders [Precision] has managed to keep it's margins up and it's balance sheets going up. ... Overall, coming out of a recession, it will be hard to beat companies such as Precision Castparts who showed their metal even in the worse of economic times.

Canaries in the Drug Coal Mine

If you're looking for an indicator of the drug industry's future research and development efforts, keep an eye on contract research organizations (CROs), which conduct research for drug giants like Pfizer (NYSE: PFE) and Merck (NYSE: MRK), as well as smaller companies.

Unfortunately, new results from two top companies, Pharmaceutical Product Development (Nasdaq: PPDI) and ICON (Nasdaq: ICLR), suggest that a turnaround in pharmaceutical R&D isn't just around the corner.

Both just posted second-quarter earnings that beat Wall Street estimates. However, shares of both fell hard afterward due to unfavorable comparisons to the year-ago quarter, concerns about R&D contract cancellations, and/or warnings that the rest of 2009 looks troublesome.

Poor prognosis
Contract research organizations have made a pretty good living by catering to companies that are cutting costs via outsourcing some clinical and pre-clinical trials. Small companies use CROs because their budgets would be strained by expensive late-stage clinical tests.

Just look at stock charts for much of this decade. Many CROs produced healthy returns for investors. However, the fall of 2008 brought the fall of CROs.

The recession plus drug-company restructurings, mergers, and acquisitions have combined to knock the (market) cap out of CROs. Many are now trading at about half their 52-week highs, and some are even worse.

Weak numbers
Sales and profits at CROs say a lot about drug-industry R&D plans, and the latest news suggests continuing drug development doldrums.

Pharmaceutical Product Development unveiled second-quarter results after markets closed yesterday. Investors recoiled today to the tune of about 15%, even though earnings per share of $0.33, excluding special items, beat Wall Street estimates by $0.04.  

Second-quarter revenue of $355.2 million was 12% lower than for the year-ago period. The $38.7 million income from continuing operations trailed the year-ago period by 20%. 

The company added $465.9 million in new business for the quarter, but it also reported $212.9 million in cancellations -- a troubling sign of R&D retrenchment. The company didn't change its 2009 earnings and revenue forecast, which it had downgraded in April.

More unsettling news
The story from ICON wasn't much better. It reduced full-year earnings per share and revenue estimates, even though second-quarter earnings per share beat the Wall Street consensus forecast by $0.04. As a result, shares are down about 7%.

ICON produced a 1% gain in revenue, to $220 million, from the year-ago quarter. Earnings per share, excluding one-time events, was $0.38 versus the year-ago tally of $0.31. 

The numbers from these two companies cast a shadow on the rest of the CRO industry, whose other major players, including Covance (NYSE: CVD) and Parexel International (Nasdaq: PRXL), will issue quarterly results up through early August.

The constant beating of CRO stocks have been taking will eventually convince investors that some are cheap enough -- and fundamentally strong enough -- to merit attention. Right now, it's a choice between (heaven forbid!) market timing and faith in a still-uncertain R&D recovery.

 

 

10 Stocks Shaking the Market

 

Some stocks are one-hit wonders, making a big splash when they first appear, then quickly fizzling into oblivion. But for other stocks, that initial big move is only a preview of things to come.

Today, we've compiled a list of 10 stocks that made some of the biggest moves up over the past 30 days. We'll then pair that list with the ratings from our Motley Fool CAPS community. The higher each stock's rating, the greater CAPS members' faith in that company's ability to keep on beating the market.

Stock	30-Day % Change	CAPS Rating (out of five)
Human Genome Sciences (Nasdaq: HGSI)	410.70%	**
BioCryst Pharmaceuticals	88.09%	*
Oshkosh	86.31%	****
Orexigen Therapeutics (Nasdaq: OREX)	76.53%	**
Dana Holding	62.75%	**
TRW Automotive	59.98%	**
Nevsun Resources (NYSE: NSU)	54.21%	**
CDC (Nasdaq: CHINA)	47.02%	****
Immunomedics (Nasdaq: IMMU)	42.17%	***
Incyte (Nasdaq: INCY)	40.74%	*****

As the markets have rebounded after several consecutive losing weeks, we see that the gains are less than those experienced by the movers and shakers from previous weeks. With almost all of the stocks carrying low one- and two-star ratings, let's see why some members of the CAPS community think one of these companies might outperform the market.

A mighty temblor
A long-term investor in Human Genome Sciences can only take small solace in the huge jump in the share price the other day when company officials reported that lupus treatment Benlysta passed an important phase 3 milestone. After all, the stock price is still about 89% below the high point it reached in 2000.

Yet, more recent converts to the biotech's story no doubt are basking in the glow and eagerly await the next, albeit low, hurdle set for November,   when the results of a second phase 3 trial are reported. Because the test is set up essentially the same as the one just completed, it should bring straightforward results.

The risk isn't necessarily that the drug won't pass the test, but that the condition it's taking on has a track record of sending drugs off to die. Lupus occurs when the body attacks itself, causing skin rashes, inflammation of the kidneys and tissue surrounding the heart, and pain and swelling in joints virtually anywhere in the body, making it difficult to treat. Despite the failures that have preceded it, Human Genome Sciences' therapy may be one of the best hopes for patients.

While the next clinical trial results might not result in another surge in the stock's price, investors might reap a windfall nonetheless. Human Genome Sciences is partnering with GlaxoSmithKline (NYSE: GSK) to market the drug; estimates are that it could earn $1 billion in annual sales if it's approved. That might be just enough incentive for Glaxo to buy the biotech company outright, particularly because it has said bolt-on acquisitions are right in line with its growth plans.

CAPS All-Star UltraLong, with a perfect 100.00 rating, remains unswayed by the recent success, noting that an irrational market is assigning unwarranted valuations to many biotechs. The test results may be a good start for Human Genome Sciences, but there's little justification for the valuation, let alone revenues.

You know the apocalypse is near when Human Genome Sciences is outperforming the market. This company was written off for dead back in March after yet another failed drug study.

So let's analyze what we have here. They finally, after countless [tries], found a drug that works better at controlling the pain and inflammation associated with lupus, potentially a 2 million person market. Now I'm not saying 2 million people aren't worth it, but perhaps they could have been lucky and pushed through a clinical trial for a drug that [affects] more than 0.0003% of the population.

So assuming this gets quick review status from the FDA, it will still be until early 2011 before any material impact is seen from the revenue of this drug. I would peg this as extremely unlikely to get this company to profitability. The underlying fundamentals here are a joke and always have been. A negative book valuation of 2 cents, nearly 600M in long-term debts compared to cash on hand of under 200M and a rich history of losses.

The 240 companies with the CAPS Biotechnology tag have been carried up in the past 30 days by the performance of stocks like Human Genome Sciences and Targacept, which also tripled. Stocks with this tag are up 14%, better than the 7% return of the S&P 500.

 

Let's Stand Up to Scandalous Stock Options

"So now that the stock price has doubled, are you going to reprice your options back up?"

That question silenced Home Inns (Nasdaq: HMIN) investor relations manager Ethan Ruan when we met with him at the company's headquarters in Shanghai, during our recent Motley Fool Global Gains research trip to China. He'd just finished telling us how excited management was that they'd gotten such a good strike price ($7.26 per ADR) on the stock options they canceled, then repriced and re-issued.

Newsflash, Mr. Ruan: Potential investors don't like hearing how excited management is about their latest move to bilk outside shareholders.

And your explanation was a stupid one
Asked why the company felt it necessary to re-price all of the unvested, out-of-the-money options it had granted to senior management, Mr. Ruan responded that the company worried that having options with such high strike prices -- Home Inns' stock dropped 85% in the year preceding the October 2008 option reissuance -- would demotivate employees and possibly cause retention issues.

This is a tough pill to swallow. The company's founders and senior officers already owned hundreds of thousands of options with a strike price of $11 per ADR or less. Furthermore, those company directors and executive officers (as of the last 20-F filing) already owned 15% of the stock. I find it hard to believe these key folks were going anywhere.

In addition, it's not like the stock market unfairly turned on this company, costing executives compensation to which they were rightly entitled. The team here took many steps that destroyed value, including the ill-conceived and -executed acquisition of unprofitable rival Chinese hotel chain Top Star, an inability to control rising expenses, and the launch of a new concept -- the H Hotel -- that the company, according to Mr. Ruan, has no intention of growing.

These efforts have consumed capital at an alarming rate. The company recently had to sell an additional 7.5 million shares to Ctrip.com (Nasdaq: CTRP) to raise a needed $50 million. (Incidentally, Ctrip.com was founded, and remains largely owned, by some of the same folks who founded and own Home Inns.)

So stay away from Home Inns
Of course, while Home Inns is a particularly egregious example of the inanity of options repricing -- not to mention the company that gave us the most stupefying quotes of our trip -- it is far from the only culprit. In fact, thanks to the significant stock market decline of the past 24 months, companies around the world are looking at how, and by how much, they can reprice existing stock option compensation packages.

For instance, eBay (Nasdaq: EBAY) shareholders recently approved a plan to reprice employee options. Google (Nasdaq: GOOG), Williams Sonoma (NYSE: WSM), NVIDIA (Nasdaq: NVDA), and MGM Mirage (NYSE: MGM) are among the companies that have completed or proposed some form of repricing to improve morale and sustain retention.

To be fair, some companies -- though not all of them -- have excluded top management from eligibility here. But even so, there isn't a surplus of high-paying jobs out there today. How many employees, faced with worthless stock options, will really pack up and move on?

The fact of the matter is …
Shareholders should be outraged at the suggestion that stock options should be repriced in the wake of this financial collapse. After all, those options were intended to align employee and shareholder interests, and specifically designed not to be a guaranteed form of compensation. Since shareholders can't reprice what they paid to buy a stock, repriced stock options subvert even the illusion of alignment.

Furthermore, repriced options hurt outside shareholders by diluting their ownership stake and therefore their claim on earnings. This makes every individual share worth less over the long run.

The bigger picture
Option repricing is just one more example of a situation where people who were happy to reap enormous profits when things were going well are now unwilling to accept the consequences after things have turned south. Sound familiar? This is precisely the culture that drove the folks at places like Fannie Mae and AIG to take undue levels of risk, because they figured they'd be bailed out if they failed. And the bailouts came -- while executives have largely kept the profits they piled up en route to our current housing collapse.

This is absurd. If you can't handle the downside, don't accept variable compensation.

Stand up to scandalous stock options
A number of us here at the Fool are actually surprised that in our litigious society, there hasn't been some form of shareholder-driven class-action lawsuit brought against companies that reprice options, perhaps based on the fact that doing so means that these companies' financial statements have underreported their actual cost of employment. Google, for example, which does not require shareholder approval to reprice its options under its 2004 plan, will record a charge of $460 million in 2009 as a result.

At the end of the day, companies that grant options one year tend to grant them every year. Thus, why should they reprice any old options in lieu of just issuing new options at today's lower prices? That creates incentive right there.

Getting back to the question that stunned Mr. Ruan of Home Inns, why shouldn't a company reprice options that are deep in the money back upward? After all, if it makes sense to lower option strikes when they are out of the money in order to motivate employees, why not do the exact same thing when options are priced so low that they no longer represent a target?

Those are rhetorical questions
The answer, of course, is that options have been revealed to not be a motivation tool -- at least, not in the way they're actually used. Instead, they've become a way for executives and employees to make money at shareholders' expense, regardless of how those executives and employees actually perform.

Now in some cases, you have the right as a shareholder to vote against repricing plans. But even then, these proposals are likely to pass. So instead, think hard about simply not buying shares of companies that engage in this practice. Because if they do it down the road, it means they're underreporting their real expenses, and thus deserve lower trading multiples than their financials might otherwise suggest.

Finally, economics aside, why would you want to go into business with people who, on the tail of operational missteps and a grievous stock market decline, seek to lock in their own long-term compensation at what may turn out to be the most expensive time possible? It's just not worth the trouble.

 

 

5 Stocks Ready to Bounce Back

However hard the market slams a stock, there's always the chance it'll come bouncing right back. We'll consult our Motley Fool CAPS community to find shares on the rebound, by examining one specific sector of the economy in search of companies with rising CAPS ratings.

Among the 518 stocks listed under "Basic Materials" in the CAPS' screener, we've unearthed a handful with top five-star ratings. Those accolades mean that our 135,000 CAPS investors are confident that these stocks will beat the market in the months ahead:

Company	CAPS Rating Today (out of 5)	Recent Price	52-Week Price Change	Estimated 5-Year Growth Rate
Chesapeake Energy (NYSE: CHK)	*****	$20.53	(58%)	8%
Huntsman (NYSE: HUN)	*****	$5.60	(60%)	3%
Titanium Metals (NYSE: TIE)	*****	$8.53	(22%)	(5%)
Transocean (NYSE: RIG)	*****	$77.67	(42%)	20%
USEC (NYSE: USU)	*****	$5.83	11%	10%

Sources: Motley Fool CAPS; Yahoo! Finance.

In the "Basic Materials" sector, you'll find a broad range of companies spanning diverse industries, from metals and mining to energy and chemicals. It includes not only well-known industry leaders such as Huntsman and Halliburton (NYSE: HAL) but smaller, more obscure names such as Zion Oil & Gas (NYSE: ZN) and specialty chemicals maker Solutia.

Some spring in its step
One of the biggest arguments in favor of a recovery for natural-gas producers like Chesapeake Energy is that prices for natural gas remain near historically low levels. As depressed as prices are, investors believe that relief is on the horizon. CAPS member trhdawg likes both the company and the industry: "Long Term Play - Natural Gas has been at its lowest since almost 1994 (3 dollars something) , I am buying all the oil services, natural gas companies, and energy etf's and waiting on them for 6-12 months. ... Sometimes a contrarian play is what is needed."

A forward-looking mindset like that is necessary here. Natural-gas inventories remain flush, standing some 19% above the average five-year level of 2.43 trillion cubic feet. Even Halliburton, the $20 billion energy-services company, says not to expect a recovery in North American gas drilling for the remainder of 2009.

A similar cautionary stance is probably in order for both gas and oil drillers -- even deepwater companies such as Transocean and Diamond Offshore. Yet Transocean just snagged a cool, $510,000-per-day contract from Petrobras for three years' worth of work starting early next year, so there are still drilling contracts out for the taking. CAPS member bkwfool says that Transocean's top-dog position will allow it to withstand the economic malaise: "Relatively low [debt] for a driller, so should weather the economic downturn and lower oil prices. Then, poised to break out as the leading off-shore drilling rig provider."

Similarly, strong growth potential can be found in Titanium Metals, which is valued more cheaply than rival RTI International and has generated copious amounts of free cash flow over the past three quarters. Although it's given back some of its recent gains, Titanium Metal's stock has advanced by more than 35% over the past three months and has doubled off its March low. Among other things, that kind of price rebound has attracted investors such as CAPS member jscagli:

Strong financials. Department of Energy submitted a license application for a nuclear waste repository with the [Nuclear Regulatory Commission] in which the design implements a titanium drip shield that will require nearly half the world's supply. A [judgment] is expected over the next 2 to 3 years to begin construction

 

 

Roundtable: Was This Small Cap Crashproof or Just a Lucky Survivor?

The Motley Fool Hidden Gems team spends a lot of time talking stocks. Seriously. Given the choice between hanging out with us and watching glaciers flow, and most folks will head home to pack the earmuffs and long underwear. So pack your crampons, folks, because early this week, I asked the team to reflect on the surprisingly good earnings from Hidden Gems portfolio candidate Autoliv (NYSE: ALV). Here are our responses to the following question:

This week, car safety equipment manufacturer Autoliv reported better-than-expected numbers, and the stock enjoyed a nice bump-up. Analysts were surprised by both its revenue tally and its profitability. When we recommended this company to Motley Fool Hidden Gems members in our March 2009 issue, it was, to put it politely, not a welcome idea. Car sales were terrible and getting worse. General Motors and Chrysler were teetering on the brink. Many thought Ford (NYSE: F) was next, and we didn't know what was on the other side of the cliff.

The outlook is a little bit sunnier today. Auto sales have rebounded (ever so slightly), and to date, Autoliv shares have returned more than 100% since our recommendation. What lessons can this story teach small-cap investors?

Nate Weisshaar, senior analyst:
I think the lesson for small-cap investors is to look for the Rolex in the wreckage. The auto industry has slammed into an abutment, but we are still going to be driving cars for the next couple of decades (unless the administration's plans for nationwide hamster tubes are implemented). With Autoliv, we were able to look past the smoke and airbag dust, as well as the combination of some short-term credit issues and a bout of questionable capital management, to find a best-of-class operator with an increasingly important niche in auto safety. While the outlook for the overall industry looks bleak over the next few years, Autoliv's focus on efficient operations should mean it will be part of the exclusive club of last auto suppliers standing.

Mike Olsen, senior analyst:
What Lao Tzu taught us in that college philosophy class: "The words of truth are always paradoxical." Take one part emotion, one part uncertainty, and one part financial crisis. Mix with a fundamentally good company, subject to already horrible industry conditions. The result: an unbelievable range of possible outcomes. Truth told, Autoliv looked cheap, and it was. But it could've been cheap for good reason: GM and Chrysler were on the fritz, while Autoliv faced the possibility of some big operating losses and continues to deal with very beleaguered consumers. This pick worked out great, but remember, it wasn't a foregone conclusion in January.

The lessons are twofold. First, the market can be, and sometimes is, totally irrational. That can bring untold opportunity. But second, what sometimes appears incredibly cheap -- or irrational -- isn't entirely unfounded. In investing, truth often manifests itself in shades of gray. The challenge for small-cap investors looking at distressed goods is separating the Autolivs from the Select Comforts.

Stan Huber, senior analyst:
It is important to remember that Mr. Market will often overreact both in times of euphoria and utter depression. This is particularly true for small-cap stocks because of the lack of active coverage. Early this year, we cut through the doom and gloom and took a hard look at Autoliv. We saw a company with a history of managing through cycles, a strong competitive position, and a stable management team with demonstrated capital allocation skills. Further, the company was priced at a level that implied new car sales would fail to equal historical scrap rates forever.

With industry trends toward smaller and lighter vehicles in which safety is an even greater concern, it seemed apparent that the market had overreacted to the downside. With the small companies in the Motley Fool Hidden Gems universe, an individual investor has the opportunity to profit ahead of the crowd by shutting out the TV talking heads and digging into the economics of a specific business.

Jim Gillies, associate advisor, Motley Fool Hidden Gems:
Warren Buffett has famously (and repeatedly) warned that, "You pay a high price for a cheerful consensus." To this, I offer Jim's corollary: "Embrace paying a cheap price for a cheerless consensus."  

When we recommended Autoliv, we did so against a brutal stream of negative auto industry headlines. Autoliv's history of market dominance and oversized cash generation was ignored, as was the notion of the "coiled spring" building up in the industry (by this, I mean a vehicle scrappage rate exceeding new purchases by roughly one-third), and the limited exposure to troubled Chrysler and GM.

You don't, of course, charge blindly into any cheerless consensus (many of them are well-deserved). But after "kicking the tires" and seeing that Autoliv traded at about 70% of a valuation that assumed five successive years of U.S. auto sales below 10 million (the last single year racking up such a number was pre-Ronald Reagan's presidency), Autoliv was, forgive me, as "safe" a recommendation as I've seen.

Seth Jayson, Motley Fool Hidden Gems co-advisor:
Since January, Autoliv has been a constant reminder for me to remember how much I don't know. (It upped the ante this week and left me with a busted crystal ball when, just before its earnings bonanza, I moved it from our Team 1 to Team 2, for valuation reasons.) But while we need to embrace our ignorance, there is a point at which you can buy despite your lack of foresight. And although we were pretty sure about that point when we recommended Autoliv to our members at $15.75 per share, we whiffed on adding it to our real-money portfolio in the low $20s. We were a bit anchored to that mid-teens price, and in the end, we lost out on a chance for a pretty quick 50% gain, because we were holding out for a shot at a double. That was a mistake, and in retrospect, the reasons why are more obvious.

Unlike a big, opaque bank such as Citigroup (NYSE: C), Autoliv's financials allowed a clear look into years worth of real profits and cash flow -- not just gussied-up guesses about the worth of mortgage derivatives dressed up in the guise of "earnings." And unlike more deeply cyclical manufacturers, such as Caterpillar (NYSE: CAT) or Deere (NYSE: DE), Autoliv had a history of making it through recessions without burning cash. So while it was possible that things would be different this time, and that Autoliv would crash with no airbag deployment, the smart bet, it seemed to us, was that Autoliv would perform as it has in the past, cut costs, and crank out cash. And that's what it's doing, which is why the biggest surprise this week may be that so many people were surprised.

Andy Cross, Motley Fool Hidden Gems co-advisor:
After the financial meltdown went into high gear last fall, investors lost any appetite for risk. Short-term Treasury yields collapsed as the Federal Reserve became the safe haven for risk-averse investors. "The investment world has gone from underpricing risk to overpricing it," Warren Buffett, chairman of Berkshire Hathaway (NYSE: BRK-A), wrote this year in his annual shareholder letter.

We weren't completely immune to that at Motley Fool Hidden Gems. As Seth mentioned, we recommended Autoliv in the mid-teens, but after starting our real-money portfolio, we froze up -- kind of like the credit market that threw everyone, including Autoliv, for a loop. Autoliv's debt position held us back a bit. We learned from that experience, and one response was our creation of the Rough Cut designation for stocks, like Autoliv, that have plenty of upside but also big unknowns that could sink them. Rough cuts with potential debt issues can be volatile, though, so we will tread lightly by allocating just a small percentage of the overall portfolio to them. Our usual purchases have stronger balance sheets, like cash-rich Atheros Communications (Nasdaq: ATHR).