Please Don't Buy This Stock

Here's a statistic that ought to make every long-term investor shudder, courtesy of JMP Securities analyst Michael Hecht: A mere five stocks were responsible for as much as 30% of the trading volume on the New York Stock Exchange in August.

It gets worse. Guess what those five stocks were?

Nope, guess again
Rather than transact in Wal-Mart (NYSE: WMT  ) , Best Buy (NYSE: BBY  ) , or any of the hundreds of NYSE-listed companies with straightforward business models and clean financials, these traders have been buying and selling cheap financials. Take a look at their "top five" list below:

Company

Average Daily Trading Volume,
Past 3 Months

Share Price Increase,
Past 3 Months

Citigroup (NYSE: C  )

$630 million

57%

Bank of America (NYSE: BAC  )

$259 million

29%

Fannie Mae (NYSE: FNM  )

$127 million

141%

Freddie Mac

$70 million

155%

American International Group (NYSE: AIG  )

$46 million

136%

Data from Capital IQ, a division of Standard & Poor's.

After reviewing that list, you should have two key takeaways:

Takeaway No. 1: Those companies stink!
I shouldn't have to tell you why buying any of those companies is a bad idea. But here are a few quick highlights – er, make that lowlights – in case you're tempted to trade any of those names, courtesy of Foolish financials expert Morgan Housel.

  • Citigroup is undergoing significant structural changes, was forced to sell its profitable Smith Barney unit to Morgan Stanley out of desperation, and is about to dilute the heck out of current shareholders.
  • After driving Bank of America to the edge of collapse, CEO Ken Lewis is stepping down at year's end with $68.8 million in deferred benefits and compensation. He may want to use that money to hire a good lawyer; word on the street says Lewis could face civil charges for "materially lying" to shareholders about $3.6 billion in bonuses paid to Merrill Lynch execs last year.
  • Fannie Mae has openly admitted that it is no longer being "managed with a strategy to maximize shareholder returns." According to many industry experts, shares of Fannie and sibling Freddie Mac are worthless.
  • And last, but certainly not least, we have AIG, the company that nearly destroyed our financial system as we know it. Even if this beaten-down insurer is able to sell off its assets for favorable prices and repay the government -- and that's a big if -- AIG still has to win back the insurance market's confidence to survive. That's why Morgan called the company "as speculative as it gets."   

Do any of those sound like businesses you'd like to own? Some of you must be nodding your heads, because …

Takeaway No. 2: Those companies' shares have skyrocketed!
Each of these fundamentally flawed financial companies' shares have surged over the past three months because … um … well, I actually have no idea why. These are objectively awful companies with convoluted business models, indecipherable financial statements, and shoddy management. And to top it off, they're pretty much impossible to value!

To put those three-month returns in perspective, consider that Best Buy and Wal-Mart -- two companies with strong competitive advantages, solid balance sheets, and histories of steady free cash flow generation -- saw their shares increase just 14% and 3%, respectively, over the same period. It seems that investors are eschewing high-quality companies in favor of low-priced, distressed stocks.

That hardly sounds like a successful investing strategy to me.

An actually successful investing strategy
Instead of buying shares of the flawed five above, why not focus on companies with straightforward business models, strong balance sheets, shareholder-friendly management teams, and bargain valuations? That's what Fool co-founders David and Tom Gardner do at Motley Fool Stock Advisor. One of David's top spots for new money that fits this bill is Activision Blizzard (Nasdaq: ATVI  ) , the largest video game publisher in the world.

Thanks to last year's merger of Activision (which published popular console titles like Guitar Hero and Call of Duty) and Vivendi (whose Blizzard subsidiary created the subscription-based World of Warcraft series), Activision Blizzard owns a series of strong game franchises that keep the recurring revenue flowing. And that revenue should only increase in the years to come. According to PriceWaterhouseCoopers, global video game sales are slated to increase from $41.9 billion in 2007 to $68.4 billion in 2011.

But though Activision Blizzard has nearly $3 billion in cash sitting on its balance sheet and is on pace to generate $1 billion in free cash flow this year, the company's stock is still trading 20% below its 52-week high.

Want to learn more about Activision Blizzard, or other great companies you'd actually want to own? Click here to join Stock Advisor free for 30 days. There is no obligation to subscribe.

Already subscribe to Stock Advisor? Log in at the top of this page.

Rich Greifner owns shares of Fannie Mae and Freddie Mac, but wishes he didn't. The Motley Fool owns shares of Best Buy. Best Buy and Activision Blizzard are Stock Advisor recommendations. Best Buy and Wal-Mart are Motley Fool Inside Value recommendations. The Motley Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (68)

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 October 05, 2009, at 4:43 PM, dennis6969 wrote:

    I have a couple of hundred thousand invested in some of the quality stocks, but bought a few thousand dollars worth of the C stock a month or two ago and sold it when it doubled in price.

    not much risk on the down side from cheap to zero was not much money) and as it turned out, sold out with 100 percent gain.

    BUT, again, not much money invested in that.

  • Report this Comment On October 05, 2009, at 5:23 PM, stockmajor wrote:

    C and BAC are good investments going forward. The government has created conditions to allow these banks to earn their way out of this mess, and they will. They are, therefore, good investments. Wait and see, oh naysayers.

  • Report this Comment On October 05, 2009, at 5:30 PM, gilsh wrote:

    it might be fun to throw all these five together, but Fools should always remember to work by the basics: You check one stock at a time. You check the stock over and over, and only then you judge it.

    There are too many parameters to consider, when speculating on stocks that aren't classic growth or value investments.

    I'll throw in only a few parameters and points, which, in my mind, should be considered as well, regarding the "terrible 5":

    the first parameter is time: is buying C or BAC now, for a planned period of 20 years, really a speculation ? can you really say that, considering the swiftness in which these organizations are releasing themselves from the government's grip ? the power of these brands ? the time frame doesn't have to be a lifetime, but not all investments in such stocks are made for a quick buck.

    But even if we are talking on a shorter time frame, if we are talking about BAC and AIG:

    Others, better than myself, checked BAC and found it worthwhile to invest. even insiders of BAC buy that stock. and what did Rich Griefner had to tell us about Bank of America ? that Ken Lewis sucked ? he is out, you know. If you seek stock-market-orientation-management, you've got to like that.

    AIG is a mystery. to everyone. which makes it a type of a speculation, no doubt. How can you value a giant insurance conglomerate which owns telephone companies in eastern europe ? No one knows. What is clear, is that AIG now has new leadership, of the type that knows insurance, and knows that EVERYONE's interest is that AIG will continue to operate as it did prior to that CDS crisis. Robert Benmosche has proven so far his leadership, and although his record in AIG is extrememly short, his past should be enough to give him credit. again, this isn't my opinion alone. Analysts have recently graded AIG's stock price to 45$. To be honest - I don't know how they tossed that number. But considering the fact that AIG used to be insurer #1, and that the government's best chance of getting back money out of rescuing it, is by playing along with Benmosche's long-term strategy, it isn't the dangerous mad speculation it used to appear.

    as for the others. I tend to agree with the article. these are dangerous stocks. but the risk, in my mind, is much greater than BAC or AIG, and again - we need to differentiate FRE and FNM (two similar stocks) from C:

    FRE and FMN's future will be determined by politicians during the first months of 2010. It is careful to bet that both FRE and FNM will survive as institutions. It is also wise to assume that current shareholders will be severely hurt by those survival maneuvers the government will make. how severly hurt ? more than the current loss of value compared to pass peaks ? it is everyones guess, and it is what makes this a speculation...

    this comment got to long, to seriously refer to C, but I always take a look at the insiders transactions, before moving on. and I always try to find out the possible reasons behind the insiders move (after all a certain Mr. gates has been selling MSFT for quite some time now, and yet, nobody thinks this is a reason to avoid MSFT....)

    That first inspection gives C the thumbs up, and this alone, is a good reason to differ it from FRE and FNM. there is more to be said here, but the comment is way too long... sorry for that...

    [disclosure: this fool dedicated a tiny fraction of his high-risk portfolio for AIG, C, BAC, FRE, FNM at one time or another during the last 3 months, and saw a blessing in this choice]

  • Report this Comment On October 05, 2009, at 5:40 PM, Fool wrote:

    aren't you supposed to buy low and sell high? Who would buy Wal-Mart right now given their value/history?

  • Report this Comment On October 05, 2009, at 9:05 PM, BellasPosting wrote:

    People are TRADING these five stocks right now. If you dinosaurs stopped thinking like old men, you would have made a ton of cash on these stocks. Wal-Mart? Please! That stock is dead in the water. No one is buying these stocks for their retirement nest egg, they're buying them for a short term speculative play and then selling them. Do people really pay you guys for stock tips? Sad...

  • Report this Comment On October 05, 2009, at 11:15 PM, drericrasmussen wrote:

    I'm puzzled. One part of Motley Fool touts "the retailer that will KILL Walmart." Another part of MF touts WMT as "solid value." Well, it does seem that the Motley part is spot on. As for which is the Fool, time will tell. But I doube that WMT is where you will find a long-term "4 bagger."

  • Report this Comment On October 06, 2009, at 11:42 AM, Dentmonsterinc06 wrote:

    Sounds to me like someone is unhappy with their investment. Truth is the market runs on emotion not fundamentals most average day investors have no clue how to read the fundamentals anyhow. Bottom line is this Fannie Mae was trading at above $60 a share before the crisis and now it's at $1.52. I predict the stock to be valued at $36 a share in around a year or two especially since we hit the bottom of the crisis and the economy and housing market are recovering. Be smart not a fool and get on this ride while it's a value!

  • Report this Comment On October 10, 2009, at 2:29 AM, aattlee wrote:

    No idea why financials went up in the Summer?

    Huh? They raped the economy, intimidated

    two administrations, and got massive piles of

    cash as ransom, naturally they had a "surge".

    And when they get the urge again, they'll do it again.

    Where's our fair playing field?

  • Report this Comment On October 13, 2009, at 11:27 PM, 2humble2fool wrote:

    Gee, one would think that a professional stock analyst would know that it was hedge funds and other institutional investors trading in these stocks that cause the outrageous volumes. But, does the writer mention this? No! Why does it seem like some of these articles are written in fifteen minutes with the sole purpose of pumping a newsletter? BTW when was the last time you saw five MF newsletter picks appreciate this much in three months? Maybe the Motley Fool should be sending its stock pickers to school rather than hacking out poorly thought out articles like this.

  • Report this Comment On October 14, 2009, at 4:10 PM, BizProf100 wrote:

    I would generalize further; that the financial sector is broadly flawed and that higher interest rates will dramatically increase bank and insurance failures.

    The consolidation of deposits, higher operational and oversight costs and evaporation of real estate profits means a less profitable financial sector.

    Hurrah!

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