How to Spot a Stock That's a Comeback Kid

Investing in downtrodden stocks in an up market can be risky -- often there is a fundamental weakness that keeps a stock price low. But if you'd like to take a shot at bottom-fishing, here are a few guidelines to keep in mind.

Fresh off one of its best months ever, the stock market may not seem to offer much chance to take a flyer on beaten-down stocks. But Wall Street analysts point out that not all stocks took part in the recent rally and there are some potentially profitable picks for investors with a long-term outlook. In fact, five of the top 10 components of the Standard & Poor’s 500-stock index are down for the year, including names like Exxon Mobil Corp. (NYSE: XOM), Microsoft Corp. (NASDAQ: MSFT), and Johnson & Johnson (NYSE: NJN).

Bottom fishing for turnaround stocks can be risky, however. Often it’s not the economy, but a fundamental corporate weakness that causes the stock to plummet -- investing in a few of those losing companies can sink your boat. If you want to take a shot at bottom-fishing, there are a couple of guidelines to keep in mind.

Don't Try to Time the Bottom. Be patient while the stock is going down and don't jump in immediately on the first upturn. If the stock is truly going to come back, you'll make money even if you buy in at slightly above the low.

Do Due Diligence. Check out the fundamentals, such as the company’s earnings and growth potential before investing. A company with healthy cash reserve and solid earnings is a better comeback bet than one with high debt and fading revenues. Web sites such as Morningstar.com have excellent in-depth research and tools to help you find companies that have a strong balance sheet.

Where’s the Bottom? You may not be able to pinpoint the bottom precisely, but you can spot a trading range that lasts for several weeks. That’s a sign that the stock has found a support level. Bigcharts.com has easy to understand charting tools that can help you out.

Are Insiders Buying or Selling? Insiders often have a better handle on where the company is headed. It would be nice to know if they see the sort of rebound you’re betting on. Look for the link to “Insider Transactions” on the company stock pages of financial-news websites such as the Wall Street Journal or Yahoo! Finance.

Look for Leaders. A company with a solid brand name has a competitive edge and has a better chance of recovering from a setback than on that’s a marginal player in its field. Here’s where a physician’s familiarity with healthcare-related products and services can lead to solid investment prospects. If you believe in a product, and think it will continue to do well over time, you might consider investing in the company even if it hasn’t participated in the recent market rally.

In the end, don’t just look for downtrodden stocks, search for companies with strong brands and a solid balance sheet before you set off on your bottom-feeding expedition.