Sometimes stocks are so beaten-down that they only have one direction: up.

How does a stock get beaten down? Lets say a company is about to report bad earnings. The management team might decide: “Listen, we’re going to get crushed anyway. Let's write down every number we can. Let's get all the bad news out there so our comps for the foreseeable future will be enormously positive.”

The earnings come out, and the investors panic and hit the sell button. Then the selling feeds upon itself. The stock goes down 20% to 30% or more until there are no more shares left to sell.

So we have several things going for us all of a sudden:

1. No more shares left for sale.
2. The company lied. Things aren’t so bad. In fact, things are going to be pretty darn good for the next few quarters because the stock took the massive hit already.

With that in mind, here are four losers that got beaten too badly and are destined to go up:

VMware (VMW)'s spinoff from EMC (EMC) was 2007's darling child and has now turned into a bastard. The announcement second-quarter results was like throwing fuel on the short-selling fire. The stock went from a high of $125 last year to a new 52-week low of $34.17. The CEO recently got fired. Microsoft (MSFT) recently got into the business. The company guided down. Revenues missed ($456 million vs. expectations of $460 million). Management then said earnings would grow by 42% to 45% despite previously saying growth would be in the 50% range.

But let's get real for a second:

1. 42% growth and a forward P/E of just 28 is cheap.

2. The shorts need about 100 days to cover their shares. (Note that I don’t use the traditional short ratio -- shares short divided by daily volume -- since that’s not how a short-seller would realistically get out of his shares.) In other words, there is enormous buying potential, particularly with insiders (notably EMC) owning 58% of the shares and institutions owning almost all of the rest.

3. International revenues grew 68% last quarter. This is going to be the growth story for Vmware.

4. The entire industry is moving to virtual storage and cloud computing. This is a demographic trend in the IT space in the exact same way IT moved from standalone workstations to Internet computing in the '90s. The dip into the $30s creates a buying opportunity that won’t happen again. And for that matter, EMC is a buy for all the same reasons.

5. New CEO Paul Maritz has been an executive at Microsoft and Intel (INTC) and knows how to compete against those guys for enterprise customers. He was involved in the development of both Microsoft Office and Windows.

6. VMware is partnered (and in many cases these companies are investors in VMware) with Oracle (ORCL), IBM (IBM), Intel, Hewlett-Packard (HPQ), Dell (DELL) and more. These partners aren’t, as a group, going to make it easy for Microsoft to compete with VMware, which has a several-year advance on Microsoft in product development.

Click here for the next two loser stocks that should go up.

Published July 24, 2008