Is the US economy steadying, and is order returning to global investment markets? The answers to these questions seem to play out differently day to day in stock prices.

To be sure, we’re still seeing fallout in the US financial system from the overextending and overleveraging of previous years. Stocks of financial companies in particular have gone through what amount to mini-bull and mini-bear markets, as the news flow turns from really bad to not so bad and back again.

Elsewhere, however, performance is really a mixed bag. Even some of the companies in the really hard-hit industries have turned in positive surprises. US communications directory company Idearc, for example, took a major hit when it suspended distributions earlier this year, putting the accent on a decline from a high last year of 38.

The company’s downward momentum, however, reversed dramatically when it announced a huge upward first quarter earnings surprise earlier this week. Profits per share—which had been largely expected to crater—actually rose 8 percent. The company also held anticipated revenue losses from the prior year to just 5 percent—despite rising competition in a generally weak economy—and expenses fell even faster at 9 percent.

The results were pretty much in line with what management had been saying beforehand. But it was in stark contrast to the immensely negative sentiment that had built up around the stock leading up to the announcement. And the result was a lot of unhappy short sellers and happy bargain hunters who had been able to buy shares at less than twice the lowest Wall Street earnings estimates for 2009.

Idearc is by no means out of the woods yet, and it’s a suitable holding only for the very risk tolerant. Nonetheless, the action in its share price does point out that negative sentiment on the downside often outruns reality, just as rah-rah bullishness often outruns reality on the upside in up markets.

As I’ve pointed out in previous issues of Utility & Income, weak markets such as we’ve seen since last summer are your best opportunity to snap up companies cheap. The trick is twofold. First, it’s critical not to get carried away and heavily weight your portfolio toward the long shots in hopes of scoring monumental gains.

Hard times amount to stress tests, and some companies are going to crack. We’ve seen several good examples in this credit crunch/economic downturn, particularly in the more economically weighted sectors. And although it’s a high percentage bet that Home Depot, for example, is going to survive, the same can’t be said for many of its weaker competitors in the home building and materials industry.

No matter how well you pick your targets now, no one can realistically foresee how bad things may get over the next few months. Another major bank to report a huge unexpected writeoff would almost certainly put more pressure on the entire financial system. That means more stress tests that the weakest may or may not be able to absorb. And given the huge amount of suspect financial assets still out there, it’s a fair bet second quarter earnings won’t be all rosy for banks.

The bottom line: You want to limit the number of bets you make on long shots, no matter how attractive they look now. We can make a lot of money buying the Idearcs now if they measure up. But we can surely lose a lot, too, if things don’t break our way.

The second key to buying low here is to choose your targets very carefully. First quarter earnings give a pretty good indication of who’s measuring up to the ongoing stress tests and who’s not. So a careful read of the numbers and preferably scoping out transcripts of conference calls—which happily are now available online for many companies on services such as Yahoo! Finance—is mandatory.

Obviously, this is time-consuming, hard work. But that’s the only way to tilt the odds of success in your favor in this potentially profitable but highly dangerous game. If you don’t take the time to really know your bets, you’re trusting to luck, and that’s no way to play.

In my view, the best battered fare to buy is companies from sectors with great track records of weathering their woes. The yellow pages business is somewhat on the borderline here because there are competitive pressures that are changing the long-term picture as well as short-term stresses.

Idearc’s chief appeal is that sentiment had grown so overwhelmingly negative that it more than prices in any reasonable risk. But it’s going to be very challenged in coming quarters to take its business to the Internet the way the sector’s star Canadian income trust Yellow Pages Income Fund has—as demonstrated in its very strong first quarter results. Unlike Yellow Pages, which is a solid income and growth play, Idearc is a speculation.

Rural wireline telecoms, in contrast, are a far more steady business. First quarter results did show a general slowing of new broadband connections for many companies, as well as a slight acceleration in the loss of basic local phone line connections. Also, the universal service fund, long a mainstay of revenue, may be coming under attack in Washington for growing too large.

Nothing has happened yet on this front, nor is it likely to in an election year. But the possibility has added to uncertainly about the group in general this year.

Nonetheless, rural wireline telecoms that have reported results thus far are still showing very strong coverage of dividends that in some cases exceed annual rates of 10 percent. One of the largest, Windstream Corp, actually posted very strong numbers for the first quarter, topping Wall Street expectations handily as broadband growth remained strong, and it controlled expenses and basic wireline customer losses. That translated into a very strong payout ratio of barely 50 percent of operating cash flow and tremendous protection for its very generous yield.

Fellow rural telecom Citizens Communications didn’t fare quite so well in new broadband connections or wireline losses. But it did post very strong free cash flow numbers that held its payout ratio down to just 48 percent. Despite very tough business conditions, that’s a lot of protection for a dividend of nearly 10 percent.

Again, everything is far from perfect in this sector. But the best companies are still putting up numbers that support their distributions. As long as that’s the case, downside is limited, and the sentiment on this group is far too negative. Sooner or later, share prices will recover.

I also favor stocks of battered utilities. I’ve made this a theme of the Utility Forecaster advisory for many years and will for many more. The base case is, no matter how bad things get for individual utilities, they can recover by simply getting back to the basics of running their regulated essential services businesses well and cutting debt.

No matter what the economic environment, US electricity use has been on the rise for 100-plus years. Even the most strapped will pay up to keep the lights on. And demand is expected to rise by another 30 percent by 2030. That’s a lot of guaranteed revenue for power companies to build on.

As companies and sectors that have been surviving the economic/market stress tests so far, there’s been a lot of good news in first quarter earnings. Energy companies are obviously doing well, with oil bursting to more than $120 a barrel and natural gas moving toward $12 per million British thermal units. But the good fortune extends to electricity producers, particularly those selling into unregulated markets.

As I pointed out last week, the Big Three of US communications—AT&T, Comcast Corp and Verizon Communications—all posted blowout numbers in the first quarter. And that’s not likely to change no matter what happens to teetering SprintNextel or its new Clearwire venture.

The overall stock market has seen some real ups and downs over the past few months, including this week’s downward action. And it’s still severely punishing businesses that are vulnerable to a weak US economy.

But it’s also rewarding good businesses that post strong results. Make those companies the focus of your overall portfolio. Then you can play around with the long shots, secure that, even in a worst case, you’ll still be in the game for long-term wealth building.

Speaking Engagements

Tune in as KCI’s LIVE webcast events air from the upcoming Money Show Las Vegas. I will be presenting my latest insights and recommendations surrounding this year’s central theme “Managing Your Portfolio in Uncertain Times” at my presentation The Best Stocks Money Can Buy.

Registration is FREE and can be completed at MoneyShow.com, so please check out the KCI events and tune in May 12-15, 2008!