A few years ago, I was sledding with my wife in her hometown of Virginia Beach when I heard someone yell "Whooooooo, Mount Trashmore!" as he soared down the snowy hill. Thoroughly confused, I turned to my wife and asked, "Mount Trashmore -- what the heck is that?"
A dirty trick
I soon found out that Mount Trashmore is a landfill being put to new uses. In winter, covered in snow, it just looked like a great place to go sledding. In the spring, it becomes a park crowded with residents using basketball and volleyball courts, enjoying the rolling green hills, and climbing the hiking trails that surround a beautiful lake.
But underneath it all -- it's just three miles of trash!
Why should you care?
If you think about that situation, it seems eerily similar to the stock market.
Consider this: How many times do you see a share price shoot up and think to yourself, "Wow, that must be a great company"? Then, after doing some research, you find out the business is drowning in debt and hasn't made money in years.
Look at Fannie Mae or Freddie Mac -- both companies have experienced substantial prices increases over the past six months. Those are incredible returns! But what's more incredible is that they were recipients of over $50 billion in taxpayer bailout money, both companies suffer from sloppy management, and both are expected to post huge losses for 2009. Rising prices can make companies look good on the surface -- just like Mount Trashmore looked good to me -- but when you take a closer look, they're simply trash.
Take a look at some of this junk:
|
Company
|
6-Month
Price Increase
|
Total
Debt-to-Equity Ratio
|
3-Year Annualized Revenue Decline
|
Forward
Price-to-Earnings Ratio
|
|
Landry's Restaurants
|
99%
|
300%
|
(1%)
|
45
|
|
Dana Holding (NYSE: DAN )
|
360%
|
46%
|
(15%)
|
62
|
|
Brigham Exploration (Nasdaq: BEXP )
|
196%
|
304%
|
(15%)
|
55
|
Data from Capital IQ, a division of Standard & Poor's.
These stocks have seen astronomical gains in the past six months, but they're trading at ridiculously high valuations, they're riddled with debt, and their businesses are struggling during the recession. But after posting negative returns over the past three years, they're seeing spikes in their prices as if they are about to enjoy tremendous earnings growth for several years.
Some of these companies may have been smart picks once upon a time, but if you have them in your portfolio right now, I'd take your gains and toss the stocks in the incinerator as fast as you can.
Don't be fooled
In actuality, Mount Trashmore isn't such a bad thing. It employs the best possible use of urban land by combining recreation with waste management.
But stocks like the ones above don't serve a purpose anymore. They are deceptive because of their extraordinary returns and often push you along with a herd of other investors who are concerned only about short-term price movements. Think about the influx of speculative money that has gone into emerging markets in the past year -- many are calling it a bubble that's going to burst. Much of the inflow into developing markets has helped foreign stocks like Vale (NYSE: VALE ) and SunTech Power Holdings (NYSE: STP ) experience a great surge in share price. Not to say that the bump in price hasn't been warranted for these two companies; however, following "hot" money hardly sounds like a practical investing strategy.
Instead of following the pack or keeping stocks in your portfolio that clearly don't belong, why not try a simpler, more levelheaded approach? Look for companies that have clean balance sheets and limited debt, that have strong positions in their competitive landscape, and that are trading at favorable valuations.
That's what Motley Fool co-founders David and Tom Gardner do at Motley Fool Stock Advisor. They recommend companies like Hasbro (NYSE: HAS ) , Cubic (NYSE: CUB ) , and inVentiv Health (Nasdaq: VTIV ) .
Each of these companies has very manageable debt; all three have substantially increased revenues over the past five years. Cubic, under the leadership of their 94-year-old (yes, 94!) founder and chairman, has been an electronic innovator for years. Having developed the first-ever electronic stadium scoreboard in 1966, the company has continued in its tradition by being a leader in providing systems support for the military. But don't worry about any future defense-budget decreases -- this company doesn't produce tanks or planes, it's strictly involved with training, development, and support. Cubic has also increased its earnings on an annualized basis by over 7% for the last five years.
Hasbro, one of the leading makers of toys such as Iron Man and Spider-Man, has a dominant position in the game and toy market. It not only produces historical and time-honored games for children, but also has a deep catalog of intellectual property that will help it earn revenues for decades to come. Most recently, Hasbro has partnered up with Discovery Communications to create an entertainment network for children and families that is sure to complement its existing product lines. Over the last three years, the company has averaged a return on equity of 22%.
If you're having a difficult time separating the trash stocks from the good ones, our Motley Fool Stock Advisor newsletter is a great place to start. David and Tom Gardner offer two stocks every month they'd be happy to own for years, and there are currently 10 stocks they think you should buy right now. If you're interested, click here for a free 30-day trial. There's no obligation to subscribe.
Already a member of Stock Advisor? You can log in at the top of this page.
Fool editor Jordan DiPietro owns shares of Hasbro. Cubic, Hasbro, and inVentiv Health are Motley Fool Stock Advisor recommendations. inVentiv Health is a Motley Fool Hidden Gems pick. Suntech Power Holdings is a Motley Fool Rule Breakers pick. The Fool owns shares of inVentiv Health and Hasbro. The Fool has a competitive but prudent disclosure policy.
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