If every investor always had perfect information and flawless insights, there'd be no point in investing. With the proper valuation obvious to everybody, there's nothing to gain in the free market. There'd be no real buyers, no sellers, no massive mistakes -- and no huge gains.
Luckily, we don't have perfect information about everything, and the future is never obvious. Few stocks embody this reality more than network equipment maker Alcatel-Lucent (NYS: ALU) . Let's run down the pros and cons of owning Alcatel. Maybe there's a great investment lurking in this stock -- or even a terrific short.
The main reason to go long on Alcatel is pretty obvious: The stock is insanely cheap.
You can buy the French-American telecom infrastructure specialist today for 2.2 times trailing earnings and 0.2 times trailing sales. To put those numbers into perspective, a share of Juniper Networks (NAS: JNPR) goes for 27 times trailing earnings and 1.9 times sales.
Even the short-sellers have moved out of Alcatel because there's so little blood left to squeeze out of this stone. Less than 1% of the float is betting on further downside. The stock has plunged nearly 75% from yearly highs, but if there's a bottom to bounce off of, this could be it.
CEO Ben Verwaayen still has some fight left in him, which gives his company a chance to recover. Over the last three years, he has slashed $1.25 billion out of Alcatel's operating costs. Margins are up across the board, 2011 was Alcatel's first profitable year since 2005, and the cash flows aren't as deeply crimson as they used to be.
Finally, there's no doubt that the world is hungry for more, better, and faster networks. Tablets and smartphones drive bandwidth needs across the globe. Digital video is the ultimate data hog, and it's catching on in a big way. Now, Cisco Systems (NAS: CSCO) and Juniper are more well-rounded players in the networking field, but Alcatel is still very relevant to the telecom industry -- where most of the high-speed networking growth actually happens right now. It's not a bad place to be.
Reasons to sell
So things are moving in the right direction, but Alcatel isn't quite there yet.
Verwaayen will be the first to tell you so. Though the cost-cutting project is working, he told us in May's earnings call that "there's much more work we need to do." Lower costs don't do anything to shore up flagging sales. And the product mix in Alcatel's sales is skewing to the lower end, where margins are thin. Verwaayen argues that it's a temporary problem and "not fundamental at all," but that remains to be seen.
Meanwhile, analyst firm Bernstein worries that the company might default on a substantial loan payment that's coming due in 2013. If that happens, we could have another Nortel-style meltdown on our hands. To avoid that grim fate, Bernstein says, Alcatel has to get those gross margins moving up.
Hold your horses!
This is hardly the kind of risk-free stock you should buy and stuff under your pillow for decades to come. A ham sandwich most definitely couldn't run this business. That being said, Alcatel's very large market opportunities and ultra-depressed share prices balance out the risk-reward equation in my eyes.
This stock is certainly worth a nibble at today's prices, and some patience if you're already a shareholder. But just a nibble, not a buffet dive! I wouldn't mortgage my house and back up the truck here, but I also wouldn't lock in losses by selling Alcatel.
Please use our Foolish watchlist feature to keep an eye on the company as Verwaayen battles toward positive cash flows and stable sales. The company can't afford to lose market share, and it must find a way to stay relevant as mobile networks move from 3G to 4G technologies. A recent installation of 4G micro stations for Telefonica (NYS: TEF) shows that it can be done, but Alcatel is playing catch-up to other equipment vendors in this crucial segment.
The smartest investors know that outsized gains go hand in hand with increased risk. That's why they buy when everyone else is selling. Read all about this market-beating contrarian mind-set in a free report on The Stocks Only the Smartest Investors Are Buying. Get your copy right now, because it won't be free forever.
At the time thisarticle was published Fool contributorAnders Bylundholds no position in any of the companies mentioned. Check outAnders' holdings and bio, or follow him onTwitterandGoogle+. The Motley Fool owns shares of Cisco Systems. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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