These Stocks Are Trash!

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 price increases over the past year. All things considered, they offer some incredible returns! But what's more incredible is that they received more than $50 billion in taxpayer bailout money, both companies suffer from sloppy management, and both are expected to post huge losses for 2010.

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 debris:

Company

6-Month
Price Increase

Total
Debt-to-Equity

Ratio

3-Year Annualized
Revenue Decline

Forward
Price-to-Earnings

Ratio

AmeriCredit (NYSE: ACF  )

52%

356%

(17%)

26

Quicksilver (NYSE: ZQK  )

102%

218%

(4%)

38

Acxiom Corporation

90%

93%

(7%)

27

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

These stocks have brought astronomical gains in the past six months, but they're trading at ridiculously high valuations, they're riddled with an enormous amount of debt, and their businesses have been unable to sustain top line growth. Nevertheless, 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 into 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're deceptive because of their extraordinary returns, and they often push you along with a herd of other investors who are concerned only about short-term price movements.

Many growth companies like Green Mountain Coffee Roasters (Nasdaq: GMCR  ) and Cree (Nasdaq: CREE  ) have absolutely crushed the market, reaping gains of 173% and 206%, respectively.

Now I'm no hater of either of these companies, but both sport forward price-to-earnings ratios higher than 42. Sure, they're both supposed to grow above a 20% clip over the next five years, but at a certain point, any prudent investor must ask themselves if a stock is simply overvalued?

The same can be said for investors who have bet on shaky turnaround stories like Sirius XM Radio and Wynn Resorts (Nasdaq: WYNN  ) -- both companies have more than doubled in value over the past year, but you've got to start deciding whether or not your investments make sense over the long haul.

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 --companies like NVIDIA (Nasdaq: NVDA  ) , and Nucor (NYSE: NUE  ) .

Each of these companies has a very manageable debt-to-capital ratio; both are expected to grow their earnings substantially over the following year.

Nucor recently sped ahead of U.S. Steel to become the largest steel producer in the nation measured by revenues. It's done this by combining crafty technology and a knack for business sense, as it traditionally avoids unions and high labor expenses and keeps its transportation costs minimal. Over the next five years, Nucor is supposed to grow at a healthy rate of 15% per year. And with the exception of an unprofitable 2009, Nucor's five year average return-on-equity has been well north of 25%.

NVIDIA has one of the most important traits that we look for here at The Motley Fool -- an extremely wide moat. The company is a technical leader in graphics computing, and as Intel recently dropped its plan to launch its own discrete graphics processor, NVIDIA is left holding a pretty large torch. Over the last five years it's been able to increase revenues by 10% annually, and that top-line growth has most analysts foreseeing significant earnings growth in both FY10 and FY11.

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 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.

This article was originally published on Oct. 8, 2009. It has been updated.

Fool contributor Jordan DiPietro owns shares of none of the companies mentioned here. Intel is a Motley Fool Inside Value pick. Green Mountain Coffee Roasters is a Rule Breakers recommendation. NVIDIA is a Stock Advisor choice. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended a buy calls position on Intel. The Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (12)

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 April 16, 2010, at 2:25 PM, iammothrastewart wrote:

    I find it incredibly amusing that this bearish article is a reprint from October, 2009. I suppose Motley Idiot will keep reprinting it until it becomes true?

    CREE was around $37.50 back on October 9, 2009. Here we are about 6 months later and it is pushing $83.

    I suggest MF wait until the stock hits $150 to post this article again. I think the stock will top out between $150 and $225.

  • Report this Comment On April 16, 2010, at 2:25 PM, iammothrastewart wrote:

    I find it incredibly amusing that this bearish article is a reprint from October, 2009. I suppose Motley Idiot will keep reprinting it until it becomes true?

    CREE was around $37.50 back on October 9, 2009. Here we are about 6 months later and it is pushing $83.

    I suggest MF wait until the stock hits $150 to post this article again. I think the stock will top out between $150 and $225.

  • Report this Comment On April 16, 2010, at 3:18 PM, BleedGreenNWhite wrote:

    It was articles like this that caused me to begin looking elsewhere for an investment service. I thought to myself, "why would I sell stocks that are having huge runs just because they have a high P/E? Don't they have a high P/E for a reason - because they are soaring? Doesn't a stock have to keep hitting new highs to keep making new highs?" If this logic were applied to Microsoft or Cisco Systems during any point of their huge gains, investors would have left MILLIONS on the table.

  • Report this Comment On April 16, 2010, at 6:50 PM, nPuffer wrote:

    Look at the % that all the other stocks you posted and then look at Green Mountai Coffee...Not bad for a company people have doubts about......

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