The Worst Stocks to Buy Today

If you missed the best week to buy stocks, you might be kicking yourself. I know I am. The market is, after all, up 32% from its March 9 low.

But just as it was unwise to panic-sell when everyone around us was losing their heads, it's equally unwise to panic-buy now that the market is in rally mode.

The sudden switch in investor sentiment -- from stocking up on gold, potatoes, and ammunition in early March to "everything's going to be OK" just four months later -- is reason enough to be skeptical of this rally.

The key to investing success, as always, is being patient and continuing to buy quality companies trading at good values. This rally, however, has largely been led by inferior companies that had been heavily shorted and left on death's doorstep.

Trying to hitch a ride on them now may be tempting, but proceed with caution.

Garbage pail kids
Following a string of notable bankruptcies, from retailers like Circuit City to once-vaunted financial institutions like Lehman Brothers, investors rightly began to wonder who would be the next to fall.

Indeed, the futures of a number of well-known but heavily indebted American institutions were in serious doubt. International Paper (NYSE: IP  ) and MGM Mirage (NYSE: MGM  ) , for example, were at one point trading at $4 and $2, respectively. Both companies have naturally been under tremendous pressure to shore up capital and responded by selling assets, refinancing existing debt, and -- in the case of International Paper -- slicing the dividend by 90%.

Since March 9, International Paper shares have gained 237% and MGM Mirage 154%. These are just two examples of the recent "dash to trash" in this market rally. Consider the profile of the 340 US-based companies with current market caps over $300 million that have gained more than 100% since March 9:

 

Debt-to-Equity

Net Income (LTM)

Return on Capital

Median

90%

($47.9 million)

4.1%

Source: Capital IQ, as of July 6, 2009.

Put simply, this rally's been largely led by weak hands. While it may be tempting to jump on this bandwagon now, these are the worst stocks to buy today, especially since we're not completely out of the economic woods just yet. If things take a turn for the worse again, chasing these stocks could be a very costly mistake.

Instead, investors (as opposed to speculators) should focus on profitable companies that generate free cash flow, that have a track record of rewarding shareholders with efficient use of capital, and that have strong balance sheets.

These are the types of companies that will emerge from macroeconomic turmoil even stronger than before.

Names, please
Despite the recent rally, there are still many quality companies trading at reasonable valuations that are worth further research, including the following.

Company

Price to Free Cash Flow

Return on Equity

Cisco Systems (Nasdaq: CSCO  )

10.4

20.1%

Procter & Gamble (NYSE: PG  )

13.6

18.5%

Hewlett-Packard (NYSE: HPQ  )

9.6

19.6%

Oracle (Nasdaq: ORCL  )

13.4

23.2%

Adobe (Nasdaq: ADBE  )

13.1

16.3%

Source: Capital IQ.

Given their size, you shouldn't expect any of these companies to become a six-bagger in a matter of weeks the way Ruby Tuesday did recently, but you can sleep a little better at night knowing your management team isn't slashing dividends or selling assets just to pay the bills. In fact, Oracle just announced its first regular dividend, and in April, Procter & Gamble marked its 53rd consecutive year of increased dividend payouts by boosting its payout 10%.

Foolish bottom line
After sustaining significant losses over the past year, it may be tempting to chase after struggling companies that have had huge run-ups in this rally, but do your best to not lead yourself into that temptation. If buying distressed stocks was a gamble in early March, it's an even bigger gamble now that many have soared in price. Another downturn in the market and they could be going from heroes back to zeroes -- literally.

The market's still a volatile place, so remember to stay patient and focused on buying the companies that actually turn a profit, have strong balance sheets, and are led by top-notch management. Begin by building a watchlist of stocks you'd love to own if they fall another 10% to 20%. This way, you're ready to strike when the market gives you the opportunity.

Want to get started? You could do worse than to start your research with Costco Wholesale, one of Fool co-founder Tom Gardner's recommended core holdings for Motley Fool Stock Advisor. It's a consistent free cash flow generator and is led by one of the country's top CEOs in Jim Senegal, who also co-founded the company.

If you'd like to learn about the other stocks we're recommending at Stock Advisor, a free 30-day trial of the service is yours. Just click here to get started.

Already a Stock Advisor subscriber? Log in at the top of this page.

Todd Wenning hopes you're having a pleasant day. He owns shares of Procter & Gamble, which is a Motley Fool Income Investor selection. Costco is a Stock Advisor and Inside Value choice. The Fool owns shares of Procter & Gamble and Costco. The Fool's disclosure policy takes out the trash.


Read/Post Comments (7) | Recommend This Article (133)

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  • Report this Comment On July 10, 2009, at 5:22 PM, randy1990 wrote:

    the worst stocks to buy today better add Cemex to that list. You guys have pushed that stock and it is a looser you just wait and see they are bankrupt. as a former employee i can tell you that.

  • Report this Comment On July 11, 2009, at 3:20 AM, FLL1943 wrote:

    Good article--useful perspective for those who feel they've been missing the boat.

    I do find it a little unreal to do calculations from the absolute bottom--March 9-10. One had to be very brave to risk what capital was left then. Perhaps April 1 is a better date, by which time some of the rest of us were beginning to raise our heads to see what was happening.

  • Report this Comment On July 11, 2009, at 6:57 PM, plange01 wrote:

    google is getting desperate.it sounded like a great company in the begining but in the end its just a online phone book.its not going to compete with windows or the new bing.yahoo is taking back the ground it lost and its iphone copy is to little far to late. the only thing holding its stock price up is hedge funds trying to get out...

  • Report this Comment On July 13, 2009, at 3:00 PM, denaliguide wrote:

    it kinda cracks me up to watch the FUNDO struggle that goes on here as the PTB throws the market this way and that, to suit whatever purpose it has that day.

    Who ever heard of the biggest grain/corn merchant in Mexico ? Not me, but look at the msg bd on the competitor and they have lots of msgs. Yes no one really knows them, butyet they showed up, inspite of their debt problem as a Gold Medal finisher on Peak Performance Picks. Do I know why yet, NO ! Maybe I will never know why. But at least I think I know WHAT.

    http://denaliguidesummit.blogspot.com/

    is where you may go to see what I mean.

    Good Luck

    DG

  • Report this Comment On October 09, 2009, at 5:06 PM, vishtr wrote:

    Re: plange01

    Google? Really? I hope the price does come down, I would love to own some of google. It will eventually run all computer systems. I use google products as much as I use windows products. With their track record (everything they release being awesome), I will continue to switch over to google products as they are released.

    The only reason I don't own them now is that no matter how much I love a company or what industry it's in, I just can't get over that high a P/E ratio.

  • Report this Comment On November 13, 2009, at 5:27 PM, Icureasthma wrote:

    We didn't miss the March 9Th low. If you recall the market report pages on the Internet were "unavailable" as it always is when the best buy times are occurring. The phones to the brokers are"over loaded". In short the non-programmed investors are programmed out. The story by Wayne Jett on July 30, 2009 about Goldman Sachs using its illegal programs allowing it to buy and sell ahead of major up and down moves on the exchanges was reported after the first blood letting. Since Clinton and Robert Ruben, nothing is on the up and up. The left overs are all we are going to get. It's a job to find an honest balance sheet in the annual reports. They are all footnoted as though they were written in a foreign language. Straight forward accounting is a thing of the past. Puts and calls were established to beat the rules placed on margin buying and selling after the depression. Nobody said a word.

  • Report this Comment On December 04, 2009, at 11:50 PM, somdbob wrote:

    I'd like to know what's going on with the MF-promoted Independence Fund. I liked the pitch that was made and bought some--about six months ago. There was one report, covering the ten largest holdings some months ago--since then nada!

    I naively thought the Independence Fund would at least appear in the Sunday Washington Post biz section.--which appearance is also a valuable marketing/ publicity gambit, presumably free.

    Not so??

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