5 Deathbed Stocks

We've all heard of the "death rattle," the last gasp from a lost soul's lungs. Sometimes, we seem to hear it from the companies in which we invest. Revenues dry up. Margins contract. Profits evaporate. All these signs suggest that their condition is worsening -- a financial death rattle, if you will.

Stocks in sick bay
Don't assume that all such companies are goners. Some will barely cling to life, while others make a full recovery. Sure, it happens, but here we're seeking companies that have all but given up the ghost.

For help, we'll turn to the clever coroners at our 110,000-strong (and growing) Motley Fool CAPS community, where players give the thumbs-up or thumbs-down to more than 5,500 stocks. Research shows that newly minted five-star stocks offered the best opportunities for investors, while the lowest-rated companies fared worst. We've unearthed a handful of stocks that you might want to avoid, because they've recently dropped from two stars to the lowest one-star rating.

First, we'll check out some quick tests for liquidity -- the current ratio and the quick ratio (also called the "acid-test" ratio) -- which gives us an idea of a company's ability to pay its bills. A current ratio above 1.5 and a quick ratio north of 1.0 means it's able to meet its short-term operating needs. We've also added the Altman Z-Score to predict the likelihood of filing for bankruptcy protection, but please note: It's not designed to be used in every situation, and there are some limitations to it.

A company scoring 3.00 and above is considered safe, scores between 2.70 and 2.99 are in the "yellow flag" zone, scores between 1.80 and 2.70 mean the chance of filing for bankruptcy protection within two years is good, and scores below 1.80 mean "Watch out below!"

Here's today's list. The question is, are these companies only mostly dead, or have they already given up the ghost?

From Motley Fool CAPS, and Capital IQ, a division of Standard & Poor's; * as of March 31, 2008.

We obviously don't know if these companies are headed six feet under, so don't short them based on their appearance here. Even so, stocks that CAPS investors have marked down to one star are possibly destined to seriously underperform the market in the immediate future.

A market disconnect
The first time Nortel Networks appeared on this list, at the end of December, it was already a bruised and battered stock. Trading at around $15 a share, it had slid about 42% over the previous year. Fast-forward seven months and the networking solutions provider looks even more pallid than it did back then. Shares have fallen an additional 60%, losses spiked in the most recent quarter, and orders are down because of less CDMA (code division multiple access) spending by customers, one of which is rumored to be Sprint Nextel (NYSE:S). (Competitor Alcatel-Lucent (NYSE:ALU) decided to clean house, ridding itself of both the chairman and the CEO because it's also suffering.)

As we note each week, showing up on the list of deathbed stocks doesn't mean the companies will file for bankruptcy protection, but it does point to underperforming the market. And though the S&P 500 is off about 10% or so year to date, Nortel is doing seriously worse. Last month, CAPS member Gumfactor suggested that at current prices, an investor might do well with a stake in Nortel, though he doesn't think it will be an industry leader again.

This is my second run in [Nortel] in the past few months. ... Personally I think that [Nortel] is going to make a modest comeback in the next few years. Not to the point where it's a leader in its field ... but enough so that somebody who picks up some of its absolutely decimated stock should come out ahead. But at the moment, after the drop from $10.00-->$6.50, I'm just looking for a month-long swing trade. As long as the stock doesn't falter at $7.00, I think I'm good.

Middle of the road
MiddleBrook Pharmaceuticals is hoping a $100 million cash infusion from Equity Group Investments in return for shares and warrants, along with its president and CEO stepping down, will help the company keep its other foot out of the grave. Investors aren't so sure because they had been hoping for a buyout instead, and its shares were reeling last month. The possibility of a buyout was one of the reasons CAPS member hennessy7 had favored the company, which develops anti-infective products, back in June.

Couple months before "the buyout" at around $6 per share. Don't have real money here but I want to keep an eye on how reliable certain sources are.

Rattling the cage
Are these companies doomed to drag their investors along as they underperform? Or will they recover to shine again? It pays to start your own research on these stocks on Motley Fool CAPS. Read a company's financial reports, scrutinize key data and charts, and examine the comments your fellow investors have made, all from a stock's CAPS page. Sign up today, absolutely free, and let us know whether you think the Grim Reaper's at the door.