Until this point it would have been natural to assume that Congress would put aside partisan concerns and increase our borrowing capacity, as it has done 74 times since 1962. However, with the Aug. 2 deadline nearing and both parties continuing to bicker, investors need to consider how the looming debt-ceiling debacle could play out in our portfolios.

What's at stake if the United States fails to pay its bills? No one knows for sure, but things could get ugly.

• Last month, the International Monetary Fund warned that a debt default could spur "a severe shock to the economy and world financial markets."
• Yesterday, Credit Suisse cautioned that the stock market could fall 30% if the United States defaults.
• Skipping a payment to Treasury bond holders would almost certainly lower America's AAA credit rating, which would increase borrowing costs for the government, companies, and homeowners - and thus slow economic growth.

Thanks to Congress' last-minute gamesmanship, merely increasing our borrowing capacity may no longer be sufficient to stave off a credit-rating downgrade. When Standard & Poor's put the government's credit rating on negative watch last week, the rating agency warned that Congress and the administration must also provide a credible plan to address our nation's growing ratio of debt to GDP. With the two parties still far away from such a solution, the stock market is beginning to show signs of stress.

How Concerned Should Investors Be?

Should investors be concerned that the United States will lose its AAA credit rating? And if so, how should they prepare? To find the answers, I turned to two Motley Fool economic experts: Morgan Housel and Matt Koppenheffer. Although the current climate is scary, our experts agree: Selling into panic is rarely a successful strategy.

Rich Greifner: Guys, where would you place the odds that the United States will lose its AAA credit rating?

Matt Koppenheffer: To this point, I've remained optimistic and assumed that the likelihood of that outcome remained pretty low. With Aug. 2 right around the corner, though, it's hard to maintain that optimism. It's also important to remember that there isn't some clear calculation done to determine the credit rating, nor is it bond investors "voting with their dollars." It's a bunch of eggheads at Standard & Poor's and Moody's that wield this very significant power like Smeagol with his ring. As you pointed out, these folks may decide to knock the U.S. down a rung even if the debt ceiling gets raised in time.
Right now, I'm down to a coin flip - a 50% chance that the United States' credit rating falls at least one notch.

Morgan Housel: History backs up that 50% figure. We're on "negative" credit watch right now - basically, on the rating agencies' "naughty" list. And 56% of the time countries have found themselves on that list in the past, they've been downgraded.

The rating agencies have explicitly said that any plan forged by Congress and the president will need to cut the deficit by around $4 trillion over the next decade to avoid a downgrade. None of the proposals currently put forth by either political party come close to that. It's been frustrating to watch them submit plans that they have to know still risk a downgrade. I think it shows how seriously they're taking this matter.

Rich: Stock market experts are divided on the potential impact of a credit-rating downgrade. Some advocate moving to cash, while others believe a downgrade is already incorporated into current prices. Where do you stand?

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• The new children's clothing concept, P.S. From Aeropostale, is gaining traction with consumers. These stores are a drain on earnings now, but management believes P.S. will begin boosting the bottom line once the chain clears 100 locations.
• Aeropostale's website contributes just 7% of total sales, compared with about 12% for its competitors. Because online sales are high-margin, any improvement here will have a big impact.
• The company has only 10 licensed locations, all in the United Arab Emirates. These stores require no capital investment from Aeropostale and generate recurring royalties based on a percentage of sales. I expect additional licensing deals -- and high-margin revenue -- as the company expands its international presence.

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If a lumber company falls during a stock market rally, does it make a sound? This philosophical puzzle refers to what happened last Thursday to the nation's largest hardwood flooring specialist, Lumber Liquidators (LL), which operates 250 stores in 46 states and Canada.

After the company cut its full-year revenue forecast in an impromptu business update Thursday, investors took Lumber Liquidators to the woodshed, sawing 28.5% off its share price. But while the short-term macroeconomic headwinds will undoubtedly be challenging, this highly profitable company still has a strong competitive position and ample room to expand, which is why I think this flooring retailer is a good prospect for investors' portfolios right now.

The lowdown on low-cost flooring

Lumber Liquidators provides its customers the widest range of hardwood flooring options in the industry at prices lower than its competitors can offer. What makes this possible is the company's uber-low-cost store format: bare-bones warehouses in low-rent areas and just a store manager and two or three sales associates running the show. By ordering its inventory in bulk, Lumber Liquidators is able to keep its merchandise costs low.

The company's streamlined format produces phenomenal returns on capital. It costs Lumber Liquidators $300,000 to open a new store -- and all but $75,000 of that amount accounts for the inventory. The average new store is profitable within three months and returns its initial cash investment in less than a year. And because it's so cheap to build a new store, Lumber Liquidators has been able to grow at a breakneck pace. The company has expanded from 57 locations at the beginning of 2005 to 250 today, and management has set an eventual target of 400 stores.

But won't the big-box stores snap Lumber Liquidators like a twig? Don't count on it. Lumber Liquidators' locations may not be as convenient as competitors' such as Lowe's (LOW) and Home Depot (HD) or even your local mom-and-pop flooring shop, but customers are happy to drive a few miles out of their way to save hundreds of dollars on a new floor or browse a wider selection. In fact, it's the local flooring stores that should be concerned in this equation. These inefficient operators currently control about two-thirds of the market, but I expect Lumber Liquidators and the big-box stores to continue to steal those sales over time.

Why Wall Street pulled the rug out from under Lumber Liquidators

As you might imagine, this economy is a difficult environment for a company that sells big-ticket, discretionary, housing-related products. With the housing market and economy hurting, Lumber Liquidators' customer base has become much more price sensitive. While this trend should actually play to Lumber Liquidators' strengths, the company was caught off-guard this quarter and could not rein in its expense structure in time.

Part of the problem is Lumber Liquidators' fault. The company's botched implementation of a business software package last year has dragged on results for the last three quarters. While the company insists that the software issues are in the rearview mirror, last week's near-30% scalping indicates that the investment community has lost patience with Lumber Liquidators.

Opportunity knocks, investors

The market's knee-jerk reaction suggests to me that many investors are focused on the wrong metrics. While Lumber Liquidators' reduced revenue guidance was disappointing, it's clear that new Chief Operating Officer Rob Lynch's margin improvement initiatives are already bearing fruit. By renegotiating contracts with vendors and diversifying the company's supplier base, Lynch has Lumber Liquidators poised to post record-high margins by the fourth quarter.

Despite the dour macroeconomic climate and subpar first-half performance, Lumber Liquidators still expects to earn between $1.00 and $1.15 per share this year. At $18.50 per share, the market is pricing the company as if its sales trends and margins will never improve. But if Lumber Liquidators can generate a slight improvement in either category, I believe shares should be worth about $28 -- and if the housing market recovers, that estimate will likely prove conservative.

The bottom line

It's not often that one gets a chance to buy a fast-growing, highly profitable business at a bargain basement price. Take advantage of the stock market's short-term mindset and open up a position in this long-term winner today.

Senior Motley Fool analyst Rich Greifner does not own shares of any company mentioned in this article. The Motley Fool owns shares of Lumber Liquidators.

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