5 Stocks You Should Avoid Right Now

Back in March, we profiled five unbelievably solid stocks -- companies that have been paying uninterrupted dividends to shareholders for more than 45 years. That consistency is incredible.

Today, we thought we'd take the flip side of that coin and examine five stocks that are anything but incredible.

Why they are so dangerous
What first caught our eye about these five dogs is that they are among the most heavily traded stocks on our major exchanges:

Company

Average Daily Trading Volume, Past Three Months

Recent Share Price

Citigroup

574 million

$4.20

Bank of America

187 million

$16.09

Freddie Mac

49 million

$1.14

Fannie Mae

97 million

$1.02

AIG (NYSE: AIG  )

40 million

$35.10

Source: Yahoo! Finance.

Millions upon millions of these shares have traded hands -- on a daily basis -- over the past three months. That might make sense; after all, every one of these stocks has headlined the nightly news at least once in recent months.

Now, we have to acknowledge two things. First, many of these transactions were from the big-money institutions or the short-term day-trading crowd. (Still, somewhere in there is the little guy.) Second, an earlier version of this column was published in April, and we were as bearish on these five companies then as now. One problem: Since then, the five companies we called out have, on average, outpaced the market.

Why you should stay away
While it's true that they've rallied of late, we believe there are better opportunities long-term. Speculators may be able to ride the momentum … but investors would do well to sit this one out. Why? Because these stocks have three troubling commonalities:

1. A convoluted relationship with the government.
According to the Center for Responsive Politics, the "Finance, Insurance, and Real Estate" industry spent more than $3.4 billion on lobbyists between 1998 and 2008 -- more than any other industry.

What did those five companies get for all of those political contributions? All have received well-publicized bailout funds. And while the taxpayer money will be used to save these companies from a far worse fate, Uncle Sam's money comes with strings attached.

Under normal circumstances, businesses are accountable to three constituencies: their customers, shareholders, and employees. Businesses will do well when they do right by all of them. These five companies, however, are now accountable to a supra-constituency: the federal government.

That frightens us, because it's unclear how customers, shareholders, and employees will fare when these companies try to do right by the feds. That's no doubt one of the major reasons TARP recipients such as Northern Trust and Morgan Stanley (NYSE: MS  ) wanted to repay TARP funds so promptly.

2. Gordian knot-like financials.
Look at Citigroup's balance sheet. For all of the information, for all of the numbers, it's among the most confusing documents we've ever examined. Call us when you figure out what it owns and what it owes. Heck, call Citi CEO Vikram Pandit first.

See, it's seemed to us that as the credit crisis persists, insiders haven't been totally clear about what's on their books. Though some have a vague sense that mark-to-market accounting has forced them to write down asset values too far, only time will tell ... and time may not be on these companies' sides right now.

3. No near-term catalysts.
The financial companies will survive in some form -- our government has committed to that. But their future will be unlike their past. Regulation will be stricter. The massive 30-plus-times leverage that drove outperformance earlier this decade will be a dark relic of a bygone era. And now, skeptical investors may never ascribe the same market multiple to profits.

We just can't see a world in which these companies post the same kind of profits that we saw for the past 10 to 15 years.

What you shouldn't avoid right now
Contrast the future of Citigroup or AIG with, say, the future of these five efficiently run companies, each of which is trading at a discount to its five-year average:

Company

Current P/E

Five-Year Average P/E

Motley Fool CAPS Rating

Clorox (NYSE: CLX  )

15.1

19.6

****

America Movil (NYSE: AMX  )

16.8

18.5

*****

ConAgra Foods (NYSE: CAG  )

14.3

18.5

****

Pepco Holdings (NYSE: POM  )

13.4

15.1

****

Union Pacific (NYSE: UNP  )

16.2

18.9

****

Source: Morningstar and Motley Fool CAPS. CAPS rating out of a possible five stars.

This isn't a formal recommendation of these companies -- and it's not to say that they each don't face challenges. But at least they're not encumbered by convoluted relationships with the government and convoluted financials. And they can continue with business as usual while the stocks listed above are figuring out ways just to maintain.

Buy one-foot bars
Heck, there may be value in one or all five of the stocks we've advised you to avoid -- in some cases, they've more than doubled from their lows. But given their complexity, they're the proverbial "seven-foot bars" that Warren Buffett says he avoids when he invests.

Instead, Buffett looks for "one-foot bars that I can step over." In other words, lay-ups, short putts, or fastballs down the middle (to diversify our sports analogy). These are easy investments where the reward profile far outweighs the risk profile.

Fool co-founders David and Tom Gardner have found all sorts of similar opportunities for their Motley Fool Stock Advisor subscribers. That, after all, is the silver lining of a down market, and if you're prepared to be a long-term investor, you can take advantage.

Click here to join Stock Advisor free for 30 days and enjoy immediate access to all of David and Tom's proprietary research. There is no obligation to subscribe.

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

This article was first published April 9, 2009. It has been updated.

Tim Hanson owns shares of America Movil. Brian Richards doesn't own any companies mentioned. America Movil is a Motley Fool Global Gains recommendation. Clorox is an Income Investor pick. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (15)

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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 30, 2009, at 4:09 AM, JEELopez wrote:

    That list of stocks in the first part of the article was certainly a big surprise.

    I still don't understand why our tax dollars should have to be used to bail out this nation's defunct financial mess. These companies that made bolo-dodo financial moves; let them fail.

    Oh, I forgot, the government might lose tax revenue from businesses that would otherwise go under.

  • Report this Comment On December 01, 2009, at 10:23 PM, ARJTurgot wrote:

    I'd reality check that POM recommendation. They aren't particularly well run or profitable, and their margin is pretty well set by regulators. They are indeed more stable than CITI, but that's not necessarily saying a lot.

  • Report this Comment On December 01, 2009, at 10:25 PM, ARJTurgot wrote:

    I'd reality check that POM recommendation. They aren't particularly well run or profitable, and their margin is pretty well set by regulators. They are indeed more stable than CITI, but that's not necessarily saying a lot.

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