Don't Poison Your Portfolio

Most of us wouldn't knowingly ingest poison and expect a positive outcome. I mean, come on -- it's poison. That stuff'll kill you, right?

So I have to wonder why so many investors gravitate toward poisonous stocks. Cheap or not, those stocks will kill your portfolio -- and when there are plenty of good stocks to choose from, it makes even less sense.

Of course, these stocks don't come with "Mr. Yuck" stickers or more to-the-point skull and crossbones symbols to warn investors of their toxicity. But there are two warning signs that, especially in the current environment, you'd do well to heed.

Toxic business
If a company's business is in the toilet and seeing no immediate signs of recovery, that's a sign to stay away -- even if it's cheap, and even if it is likely to recover one day.

Take UAL Corp. (NYSE: UAUA  ) , for example. Although its stock got beaten down by 66.7% over the last year, over the last three months it has rallied by 43.2% as investors celebrated oil's drop from the scary highs that would have further constrained United's business.

So far, though, there's absolutely no reason to believe the airline company has fixed its actual business. Continued customer-abusive "strategies" like onerous fees for checking bags seem to be the best the airline companies can do. Meanwhile, United has a total debt-to-capital ratio of 118.9%, and in the last 12 months, it's lost a gut-wrenching $33.21 per share.

Or what about Ford (NYSE: F  ) ? Its stock has plunged 76% in the last year, and at $2, it's still not cheap. It's no secret that the Big 3 have been making some seriously bad business decisions, and, as a consequence, Ford has been blowing through its available cash and has a debt-to-capital ratio of 100.

Both airlines and automobiles tend to be cyclical industries, so there's a chance they'll come back at some point. But as noted value investor Seth Klarman recently said, at some point being too early becomes indistinguishable from being wrong -- and I don't see any reason for investors to even try to take that gamble.

Toxic debt
One of the most poisonous attributes I can think of is a high level of debt -- especially given the current credit crisis. Match that with flagging profitability (or even net losses) and declining or anemic business and you may have a toxic combination on your hands.

For example, let's take a look at a few companies with high debt-to-capital ratios.

Company

Earnings (Loss) per share (LTM)

Revenues (percentage, LTM)

Total debt-to-capital ratio

Cash

Overstock.com (Nasdaq: OSTK  )

($0.74)

13.7%

105.9%

$70.5M

Exelixis (Nasdaq: EXEL  )

($1.38)

3.1%

123.5%

$108.9M

Cedar Fair (NYSE: FUN  )

$0.29

5.5%

89.6%

$32.9M

Trump Entertainment (Nasdaq: TRMP  )

($6.23)

8.6%

87.9%

$81.5M

*All data from Capital IQ and Yahoo! Finance, 11/06/08.

These all look like hemlock to me, although some might be slightly more diluted doses than others. Cedar Fair is the only one that's managed to eke out a small profit in the last 12 months, and Trump Entertainment's loss over the last 12 months is pretty astonishing.

Exelixis is a biotech company, and granted, that industry is known for a higher degree of risk and, often, far superior rewards -- despite debt to help finance research and a near-term lack of profitability. Exelixis also has the highest stockpile of cash on the list. Still, especially in this environment, it's not a gamble I'd personally want to take.

After all, financing is harder to come by these days and interest rates choke the monies that companies bring in no matter what the macroeconomic climate. With consumers feeling strapped, many companies will also see less money coming in going forward -- and that's a recipe with a bad aftertaste.

Stocks for a healthy portfolio
There's absolutely no reason to take undue risks on such possibly toxic stocks -- especially when opportunities abound to buy strong, superior companies for the long haul. This bear market has reduced the price of any number of profitable companies with great brands and little or no debt on their balance sheets. Those are the kinds of stocks that will keep your portfolio healthy over the long term.

Tom and David Gardner have long focused on finding wholesome stock ideas for Motley Fool Stock Advisor. Recommendations Apple (Nasdaq: AAPL  ) and Nintendo are great examples of companies that are flush with cash, generate free cash flow, and have no debt -- and their recommendations overall are beating the S&P 500 on average by 28 percentage points. Why play around with poison when you can get a 30-day free trial to all of the Gardners' best bets for new money now? Just click here to get started -- there's no obligation to subscribe.

Alyce Lomax does not own shares of any of the companies mentioned. Apple and Nintendo are Motley Fool Stock Advisor picks. Exelixis is a Motley Fool Rule Breakers selection. The Fool owns shares of Exelixis. The Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 09, 2008, at 2:01 AM, dividendgrowth wrote:

    If someone had the courage to buy UAUA at $3, hohohoho!

    But if UAUA is profitable at $110 oil, don't you think it would be a GREAT buy if oil goes to $40?

  • Report this Comment On November 10, 2008, at 3:37 AM, cmolinel wrote:

    "Why play around with poison when you can get a 30-day free trial to all of the Gardners' best bets for new money now? "

    Is this a joke?

    Many bought because EXEL was and still is recommended by MDP....

    CAM

  • Report this Comment On November 10, 2008, at 9:30 AM, SteveTheInvestor wrote:

    Oh CAM..... you may have divulged classified information. Only people who pay a lot of money are supposed to know this stuff.

  • Report this Comment On November 11, 2008, at 5:48 AM, biophile6 wrote:

    Exelixis? Not since Christian Burks left, and they ate Genomica simply for their dollars.Ew.

  • Report this Comment On November 12, 2008, at 8:09 PM, mpara11 wrote:

    A bit of a conflict if you ask me. One group in the fools recommending the stock and others saying it's poison. In a down market just start new portfolios for new money. That way last years new portfolios can be swept under the rug. Eventually the market has to go back up and you will have more marketing material.

  • Report this Comment On November 14, 2008, at 3:51 PM, karakoram wrote:

    Talk about mixed signals! I am concerned about Exelixis - Did Alyce Lomax consult with her peers (including Tom Gardner) about this stock? I don't know what to make of this now... :(

  • Report this Comment On November 14, 2008, at 3:53 PM, JHW245 wrote:

    I'm going to keep playing with my Wii and ignore reality for a while. This too will pass...in time... and a shiny new president will create all sorts of interesting opportunities moving forward. If you could predict the future, you wouldn't be reading investor newsletters, so what's the point in getting mad about it? They want winners as much as you do, so they'll keep looking.

  • Report this Comment On November 14, 2008, at 7:54 PM, a46 wrote:

    And who says Motley Fool recomendations r right?

    Everything is a big lie!

  • Report this Comment On November 20, 2008, at 7:24 AM, jhatlarge wrote:

    The Motley Fool has been leading their followers to financial demise as of late. The MDP their star portfolio is down a whopping 46% with some positions down 80% + - A shell shock for those who paid $999 for the premium service. The Fool have been touting the Buffet way for years to gain investor confidence in subscribing to their service, the MF's dire performance is presently tarnishing the Buffet name and discrediting his stellar strategy with rotten picks. Would Mr. Buffet be a buyer of the MDP picks? That is the million dollar question, if so, at what price? Certainly not at the price touted by the Motley Fool to its MDP subscribers. Another question, is how much of the Fools marketing is pure hype and that of an irresponsible service to average investors who are puting their confidence and hard earned money in the MF services hoping for a safer way to play the markets. Beware! MDP is not as rosy as its made out to be. For many Foolish investors the $999 subscription was followed by sharp pain, one that is far from having instant relief.

    The MF is irresponsible and misleading.

  • Report this Comment On November 20, 2008, at 7:30 AM, jhatlarge wrote:

    Thats right, the MF is in constant conflict. Its marketing hype, the content of its free editorial news letters and the reality and advice of its paid services do not coincide and only create confusion for investors. Usually the free material is by far more cautious than its paid services.

    A class action suit hould be filed by all those who have suffered losses as a result of this irresponsible financial service.

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