Beaten-down stocks can provide investors with exceptional returns if the pessimism turns out to be unwarranted. But some stocks tumble for good reasons. Betting on a turnaround that never comes is a surefire way to lose your shirt.
Opinions vary on which stocks are best to avoid. For me, Pandora Media (P), J.C. Penney (JCPN.Q), and Urban Outfitters (URBN -0.79%) are three stocks that I want nothing to do with.
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More cash probably won't help
After failing to sell itself outright, Pandora struck a deal earlier this month with Sirius XM to sell the satellite radio company $480 million worth of preferred stock representing a 16% stake in the company on an as-converted basis. The preferred shares carry a 6% dividend, and Sirius XM will get three board seats.
That cash, and another $200 million from the sale of its Ticketfly business, will help Pandora as it aims to make its new subscription service a success. But more cash doesn't solve Pandora's fundamental problem. The company has never turned a profit, and it posted its largest net loss ever in 2016, losing $343 million on $1.39 billion of revenue. With much of its costs tied to royalty payments outside of its control, it's difficult to see a path to profitability.
Pandora's premium subscription service is also late to the game. Apple Music has 27 million subscribers, and Spotify has more than 50 million paying customers (and despite that massive subscriber base, Spotify still isn't profitable). Pandora has a large base of users that it can attempt to convert to paying customers, which could boost revenue. But any business model involving music streaming has proven to be a money-loser.
Bad companies rarely become good companies. Pandora has been around for 17 years. If it hasn't figured out how to be successful by now, I doubt it ever will.
A troubled department store
It's no secret that department stores are having a tough time retaining customers. Comparable sales have been in decline across the entire industry, and a recent gross margin warning from Macy's sent many department store stocks tumbling. A value argument can be made for some department store stocks, given their beaten-down valuations, but J.C. Penney should be avoided.
J.C. Penney's sales collapsed back in 2012 after now-former CEO Ron Johnson attempted a dramatic makeover of the company. The company managed a long string of comparable-sales increases after sales bottomed out, but total revenue remains far below pre-crisis levels. And now comparable sales are declining again, with a 0.7% drop during the holiday quarter and a 3.5% drop during the first quarter.
J.C. Penney is selling off assets, which should help reduce its debt. But adjusted for those asset sales, J.C. Penney's profits will be minimal this year. Costs have been slashed, but a retailer can't cost-cut its way to success if sales are tumbling -- at least not for very long. J.C. Penney has taken some steps to turn things around, looking to appliances and service sales to increase revenue from existing customers. But a retailer that can't draw in new customers won't survive in the long run.
A struggling mall retailer
Shares of apparel retailer Urban Outfitters are down around 55% since peaking in late 2016. The company's strategy has been in some ways bizarre (it bought a small chain of restaurants in late 2015, ostensibly to make its stores better places for people to spend more time). This hasn't stopped comparable-store sales from falling. Comps were down 3.1% during the latest quarter, and the company disclosed in its quarterly earnings filing that comps were down by a high-single-digit percentage so far in the second quarter.
That's a disastrous decline that will hit the bottom line in a big way. Urban Outfitters is not only facing the challenge of making sure it's selling what its customers want to buy, which is a constant struggle in the apparel business, but it's doing so against the backdrop of weakening retail store traffic. With online shopping increasingly becoming a viable option for apparel, all small apparel retailers are at risk.
Whether Urban Outfitters can turn things around is an open question, but I wouldn't bet on it. Apparel is one category where stores make sense; people like to try things on. But there are so many options, multiplied by e-commerce, that weaker apparel retailers are going to have a lot of trouble in the coming years. Steep comparable-sales declines are a good reason to stay away from Urban Outfitters stock.
