Is Your Stock on the Juice?

On Thursday, former U.S. Sen. George Mitchell and his team of investigators released a 409-page report whose conclusion surprised no one: Baseball has a steroid problem. As it turns out, so does the stock market.

Is there an investing lesson somewhere in our future?
Many of baseball's stars were named as users, from home run king Barry Bonds, to future Hall of Famer Roger Clemens, to comeback kid Rick Ankiel. I'd be really annoyed by Mitchell's findings if I weren't already so jaded. Steroids in baseball? Tell me something I don't know.

Like athletes, stocks can be "on the juice," too. These firms make themselves look great by manipulating their way to decent numbers. You'll often find them in our daily countdown of the "Worst Stocks in the World." 

Here are four common styles of juicing:

1. Bad buybacks
The common wisdom says that stock buybacks are good -- but that's not always true. Ailing retailer Coldwater Creek (Nasdaq: CWTR  ) recently unveiled a big buyback despite rapidly declining free cash flow. Others have used buybacks to cover options-driven dilution, as Cisco (Nasdaq: CSCO  ) , Intel (Nasdaq: INTC  ) , and Amazon (Nasdaq: AMZN  ) did in years past.

2. Changing the formula
Head-faking is a common tool of the stock-market juicer. Witness WCI Communities (NYSE: WCI  ) , which changed the way it calculated free cash flow in its second-quarter report. The result? Surprise! Better numbers.

3. Touting
Related to head-faking is the "tout," which executives use to illustrate false progress. Sequential sales growth is my favorite in this category, paling in comparison to year-over-year growth. Why? The former could easily be explained by a big deal slipping a few months. The latter usually signals real business progress. Yet none of that prevented outsourcer StarTek from touting its sequential gains in Q3. Shameful.

4. Excuses
Crazy claims can be as entertaining as they are dangerous. Lately, "the housing bust ate my earnings" has become the new "the dog ate my homework." Patterson Companies (Nasdaq: PDCO  ) tried this one in November. Office Depot (NYSE: ODP  ) followed suit yesterday. Bowwow.

Drug-test your stocks
Pretty sobering, eh? If stocks are like athletes, it behooves Fools to administer a drug test before buying. Even the best firms go on the juice from time to time. (I'm looking at you, Intel.)

Start your test by checking the financial statements. Then read the filings at the SEC's EDGAR database. (Especially the footnotes!) Next, check the press releases. Look for the four most common styles of juicing, and immediately cut the firms you catch doping.

If you're too lazy for all that, be warned -- your returns may suffer. You're probably better off adopting intuitive tools like Motley Fool CAPS to make research easier. Firms that escape the ad-hoc scrutiny of the Street rarely get past the 77,000-plus investors rating stocks in CAPS. Witness Patterson. Fools pegged the dental equipment supplier as a lowly two-star stock in CAPS long before last month's subprime finger-pointing began.

And here's the best part: CAPS is 100% free, and yours for the searching. Why not give it a try?


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