Sometimes an investment looks like a no-brainer — until you dig a little deeper.

On the face of it, Assured Guaranty (NYSE: AGO) looks like one heckuva stock. The company offers insurance policies for bond buyers, focusing on the state and local municipal bond business. It’s a good business in normal times and a great business right now, thanks to especially high premiums to insure these increasingly risky bonds.

Assured’s two main rivals, MBIA (NYSE: MBI) and Ambac Financial (NYSE: ABK) are on the ropes, enabling the company to steal market share. Assured reported second-quarter profits last week of $0.91 a share, roughly +30% ahead of consensus forecasts and a company record since being spun-off from insurance giant ACE (NYSE: ACE) in 2004. And even after a nice double-digit gain on Friday, shares trade for just 80% of book value or about six times likely 2010 profits and 4.5 times expected 2011 profits.

The “potential” in this case depends on the economy‘s cooperation.

But what happens if the economy weakens further and state and local governments start to default on their bonds? Or what will happen to state finances once the Obama administration is no longer offering support to keep teachers and policemen employed? (The Senate recently voted to give the states another $26 billion, but it is unclear if states can count on such largesse in 2011). In a worst-case scenario, a wave of bond defaults would force Assured to pay up on all of those bond insurance policies, wiping out any profits the firm hopes to earn.

Yet we may not be headed for such a dire scenario, and those fears are starting to look overblown. Assured Guaranty has been diversifying its revenue streams and is seeing more stable — and profitable — results from an acquired division that focuses on France and Belgium, which don’t face the specter of bond defaults. And the company’s reinsurance business, which helps backstop other insurers as they take on risk, is a boring but steady profit driver.

Indeed much of the upside in the most recent quarter stemmed from the fact that the most challenging parts of the business, muni bond insurance and mortgage insurance, are not doing as badly as some had feared.

To be sure, earnings are extremely volatile, as they involve a constant marking up and marking down of the perceived health of various insurance liabilities. Some investors prefer to focus on book value. UBS sees Assured’s book value rising to the $26 or $27 range during the next 12 months and sees shares rising up to almost that figure.

Yet as noted earlier, the competitive environment has clearly shifted in Assured Guaranty’s favor, and profit spreads could surge to peak levels. Some investors think a target P/E ratio is a wise way to go. In this context, if the company can avoid a wave of large bond defaults in the coming 12 months, then shares might move up to around 10 times potential 2011 profits, meaning the stock can double from current levels.

Action to Take –> The strong business trends in evidence in the second quarter remain in place, setting the stage for more estimate-topping results in the coming quarter. Shares are likely to have a solid floor under them, even after a recent run in price.

From there, perception is everything. If investors come to think that state and local governments can muddle through this crisis without defaulting on bonds, then shares should steadily climb through the $20s in the near term. And if states and cities actually do avoid a total financial meltdown, then this stock could double. Conversely, if state and local finances weaken even further from here, then shares will move into the doghouse.