Home Run Stocks You Should Never Buy

Growing up, you probably had a favorite baseball player. Being a Philadelphia native, mine was Mike Schmidt. Considered probably the best third baseman of all time, Schmidty led the league in home runs for eight seasons, RBIs for another four, and sits at number 14 on the all-time home run list.

He was a true slugger, and I loved every bit of him.

Was Schmidt really that good?
Like every baseball fan, I spouted off stats like they meant something, but as Michael Lewis points out in Moneyball, stats are deceiving in several ways. They magnify essentially small differences, they conflate circumstances with skill, and they're often looking at the wrong thing.

For example, we place absurd emphasis on home runs and RBIs. While RBIs are considered an individual achievement, to knock runners in, runners have to be in scoring positions. The best swing in the world won't earn RBI points if the bases are empty.

And it turns out that, in the end, home runs and RBIs are poor predictors of overall success. The metrics that matter, however -- on-base percentage and slugging percentage, especially in combination -- aren't very well known.

Johnny Bench? Reggie Jackson? They come to mind as some of the greatest players of all time, but what about Stan Musial? Or Mel Ott? Both of the latter players are significantly lesser known, yet the stats that matter are just as good or better. They're on the all-time list for walks, and consequently, they have higher OBPs than both Johnny Bench and Reggie Jackson. Oh -- and they have World Series rings as well.

I thought you were supposed to talk about stocks
The same problems with numbers happen in investing as they do in sports. The exciting, easy-to-find numbers often obscure the deeper stats that make the real difference between success and failure.

For instance, I often look for companies with low debt-to-equity ratios, substantial free cash flow, and forward growth rates above 15%. Both Crocs (Nasdaq: CROX  ) and Marvell Technology Group (NYSE: MRVL  ) fit the above criteria. However, when I dig deeper, I find that both have negative returns-on-equity and have had problems sustaining revenue and earnings growth. Low debt and positive free cash flow (they usually come together) are excellent traits -- but they don't outweigh other problems.

If I'm looking for stable, dividend-producing stocks, I usually seek out companies with low multiples, high yields, and positive returns-on-equity. Annaly Capital Management (NYSE: NLY  ) , Cherokee (Nasdaq: CHKE  ) , and Reynolds American (NYSE: RAI  ) all look great on the surface -- until I realize they have payout ratios of 163%, 149%, and 99%, respectively. High payout ratios can be a great indicator of companies that are vulnerable to dividend cuts or that are living beyond their means.

The bottom line: On the surface, all of these companies look like home runs. But when you look at the numbers that really matter, they're companies that you should be wary of.

The complete package
Hank Aaron has it all -- he's on the all-time home run list, he's on the all-time walk list, he has a World Series ring, and most importantly, he has an on-base percentage that rivals most. He's the complete package -- and you want the same from your stocks.

The experts at Motley Fool Stock Advisor use the same philosophy when recommending great stocks. They look for attractive valuations, clean balance sheets, and stable companies, but they also look at the whole picture -- just because a company has great cash flows doesn't necessitate a "buy." Just because a company pays extraordinary dividends doesn't mean it will continue to do so in the future. They keep digging; statistic after statistic, until they find stocks that form a complete package.

For instance, Cintas (NYSE: CTAS  ) has been increasing their dividends for 26 consecutive years, has a low payout ratio, a low debt-to-equity ratio, and has consistently grown revenues over the last five years. Stock Advisor recommended it, and it's beating the S&P by over 7 percentage points since that recommendation.

Tom and David Gardner, co-founders of the Motley Fool, recently advised members to buy Cubic (NYSE: CUB  ) , a company that specializes in the design and development of defense electronics. Cubic has almost zero debt, significant free cash flows, and a 10-year annual growth rate of 18.8%. Furthermore, the 93-year-old owner and founder (yes -- 93!) has consistently delivered to shareholders and owns lots of stock himself, something that is always a great sign when searching for dedicated management.

If you want to outperform the market -- and Stock Advisor is outperforming the S&P 500 by 52 percentage points -- then you've got to find stocks that meet all of the important criteria, not just the most popular ones. If you'd like to see what else fits that bill, you can sign up for a free 30-day trial --- there's no obligation to subscribe. Just click here to get started.

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

Fool contributor Jordan DiPietro doesn't own any of the shares mentioned above. Cintas and Cubic are Motley Fool Stock Advisor recommendations. Cintas is an Inside Value pick. The fool's disclosure policy is an avid Philadelphia Phillies fan.


Read/Post Comments (17) | Recommend This Article (88)

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 January 08, 2010, at 4:38 PM, OklaBoston wrote:

    With all due respect to Schmidt, the best 3d baseman ever was Brooks Robinson. Schmidt need not be ashamed of being second to Brooksie, but he was.

    I'm a Red Sox fan, not an Orioles fan, BTW.

  • Report this Comment On January 08, 2010, at 4:43 PM, rae13164 wrote:

    Your CUB stock simultaneously attracts and frightens me...the additional information I'd need to call my broker is, how critical is the current contribution of this 93-year-old to the continued success of the company, and what succession plans are available...eg, think Steve Jobs and all the worry about Apple collapsing without him at the helm.

  • Report this Comment On January 08, 2010, at 4:46 PM, TMFPhillyDot wrote:

    @ oklaBoston,

    Haha. Thanks for the comment. Yes, possibly a bit of hometown bias. Both were great -- and I'm sure Schmidty wouldn't mind taking a backseat to Brooksie.

    Best,

    Jordan (TMFPhillyDot)

  • Report this Comment On January 08, 2010, at 4:51 PM, TMFPhillyDot wrote:

    @rae13164,

    Yes, a very valid point -- there is certainly a downside when there has been a leader/CEO at the helm for such a long time. However, Walter J. Zable, the founder, has brought in a very talented management team around him, which includes his son, Walter C. Zable. Succession is very much a part of their future plan, as it should be when you have a 93 year old leader!

    Thanks for the comment.

    Best,

    Jordan (TMFPhillyDot)

  • Report this Comment On January 08, 2010, at 6:24 PM, DownEscalator wrote:

    Please give credit where it's due. Actual baseball statistics reevaluation began in the 80s with the SABR and, most importantly, Bill James.

    Michael Lewis' Moneyball is a highly overrated book that's been practically disproven where it was novel. Like Steve Stone and others have said, when the A's were winning big with a small budget, they had three stud starters and two MVP candidates playing for cheap. The book makes it seem like Billy Beane was the only person in baseball who understood the value of a walk, which is blatantly false. Other GMs (Braves, Mariners, etc.) had been incorporating sabermatics into their decision-making processes as a make-up for spending gaps with the advent of computers and the writings of James and others.

    That catcher that gets heavy focus in Moneyball who others considered undraftable but Beane took in the 1st round? 10 career at-bats, all in Sept. 06. To take him, Beane passed up on Joey Vatto, Brian McCann, and Chris Snyder.

  • Report this Comment On January 08, 2010, at 7:33 PM, TMFPhillyDot wrote:

    @ downescalator,

    I totally agree that Bill James deserves the lion share of the credit. Not sure if you read Moneyball, but Lewis certainly gives credit where credit is due. He talks a lot about James & SABR, etc.

    Thanks for reading,

    Jordan (TMFPhillyDot)

  • Report this Comment On January 09, 2010, at 12:13 AM, Fool wrote:

    Sorry, but I don't know what a "payout ratio" is. What does it mean and how do you calculate it? Annaly pays out all its profits in dividends. What is the relationship to "payout ratio"? Thanks.

  • Report this Comment On January 09, 2010, at 7:25 AM, Fool wrote:

    Hmmm. You say that on-

    base percentage and

    slugging percentage is

    important and then you

    agree that Robinson is

    the best third baseman

    of all time. Schmitt's on-

    base percentage was

    .380 compared to

    Robinson's .322 and his

    OPS was .907 compared

    to Robinson's .723. Good

    thinking.

    And then you make a comment that suggests that Jackson and Bench didn't win World Series rings. Even more amazing -- just how did Jackson get the "Mr. October" nickname?l. And Bench was a key member on the best team of the past 50 years.

    I hope you're better with stocks than baseball.

  • Report this Comment On January 09, 2010, at 8:26 AM, oldfart139 wrote:

    Annaly is organized as a REIT, so payout ratio is meaningless for them.

  • Report this Comment On January 09, 2010, at 9:41 AM, dragracerdad wrote:

    To rae13164, (RE: CUB) one man usually doesn't make a corporation. But to give you fair credit, one may know how to navigate the vessel. Walter J Zable is 94 by the way. Walter C Zable is 63. I believe genius is genetic. Being an elevator systems troubleshooter for 30 years has brought much talk and stories to our household. My 24 year old son has chosen my vocation and he knows more already from just being around me listening to my banter than I did at 30.

    Walt C was 13 when dad started the business. He has been wallowing in this industry for 50 years. Common sense and unconventional thought processes just seem to permeate ones persona after a while. There are exceptions... I don't think this is one of them. When Walt J swipes his card the last time, I'm sure he's smart enough to have already set the table for tomorrows dinner.

    The company is very responsible with their money. And their products are sought globally. I'm playing this winner long and feeling good about it.

    Walt J has had 50 years to assemble a winning team. I haven't any doubt in the mind of a genius.

  • Report this Comment On January 10, 2010, at 9:55 AM, jojopuppyfish wrote:

    "...and sits at number 14 on the all-time home run list."

    For grammar purposes, he doesn't sit at #14, he is ranked at number 14 on the all-time home run list"

    I own Cherokee and while you are correct about the payout ratio, it should also be noted that they only have about 10-20 employees on staff....which I think is amazing for a public company.

    The biggest complaint with them is that too much of their business is with Target.

    But I find the business model compelling:

    They buy trademarks of clothing and hire companies to produce their product.

  • Report this Comment On January 10, 2010, at 5:48 PM, dinksta wrote:

    To Fool: You can calculate the payout ratio by taking a firm's annual dividend payment per share and dividing that figure by its EPS (earnings per share). The payout ratio gives a measure of the percentage of its earnings that a particular firm pays out in the form of dividends.

    REIT's have to payout at least 90% of their earnings, I think.

  • Report this Comment On January 12, 2010, at 3:37 PM, fungifan wrote:

    Not saying he is better or worse but any time conversations about greatest 3rd baseman take place without mentioning Eddie Matthews I think them less than complete. Hitting stats compare phavorably to mike schmidts and fielding numbers aren't too bad either. To be fair I don't think you can completely dismiss George Brett and Ron Santo. If you are talking strictly offense you may want to think about Madlock and Boggs too.

  • Report this Comment On January 12, 2010, at 3:46 PM, fungifan wrote:

    BTW I think Cherokee is a pretty amazing story as well. While they are now beginning to deal more with some more recognizable labels, they have for a long time used their own name and others to provide mid level retailers their own quality "store brand". This is still the tactic they are using in expanding into foreign markets. I first bought this stock in summer of 08 as a play on people buying 'generic' rather than name brand shirts during the holiday season of 08. While I've only seen decent price growth, which lately has partly evaporated, I have enjoyed the strong dividend return for 7 quarters. My entire stock investment cost has almost been recouped in a little over 18 months

  • Report this Comment On January 14, 2010, at 11:13 AM, jpjjp wrote:

    Stupid post. Those who bought CROX this year at 1$ have done well despite the fools * rating

  • Report this Comment On January 19, 2010, at 8:20 AM, unagiboy wrote:

    Wow, this article is poorly researched and misleading. NLY is required by law to pay out 90% of its taxable earnings as dividends, which are not the same as its net earnings. NLY's low multiple, high yield, and strong ROE re indeed the relevant measures to look at. The risk to Annaly is a steep book value write down in the event its leveraged portfolio of long-duration agency mortgage securities drops in value in the face of rising long-term rates. That's the risk you are getting paid 17%+ annually to face, not the risk it is paying more than it earns.

    On the flip side, because NLY's leverage is significantly lower than it has been in past bullish cycles, there is room for them to increase the leverage of their portfolio to more normal levels in the event that long rates rise, which would lead to even bigger spreads on the new loans.

  • Report this Comment On January 19, 2010, at 9:46 AM, jonkai wrote:

    or you could make a stupid rookie mistake, and not realize that the payout ratio in some companies includes depreciation and non cash expenses....

    so you were supposed to use a cash payout ration...

    geesh man... get a grip... you think NLY has been trading like that for 15 years without someone noticing their payout ratio until you came along?

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1080446, ~/Articles/ArticleHandler.aspx, 10/31/2014 7:04:49 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement