1 Stock You Should Avoid Right Now

In April 2009, just as the overall market was gaining steam to head higher, we wrote a little column about five stocks we thought readers should avoid. Our track record since then has been pretty good:

Stock or Index

Return Since April 9, 2009

S&P 500

29%

General Motors

Delisted from NYSE, entered bankruptcy

Fannie Mae

Delisted from NYSE, entered bankruptcy

Ford

174%

Citigroup (NYSE: C  )

27%

Bank of America (NYSE: BAC  )

39%

We were prescient about the trouble that was to come for Fannie Mae and GM. And though Citigroup is up 22% since then, it lags the overall market (which slightly lags BofA's return). Regarding Ford, we were clearly wrong.

What first caught our eye about these five stocks is that they were -- and still remain -- among the most heavily traded stocks on our major exchanges:

Company

Average Daily Trading Volume, 3 Months Prior to April 9, 2009

Average Daily Trading Volume, Trailing 3 Months

Citigroup

48.1 million

506.0 million

Bank of America

43.7 million

147.0 million

Ford

40.8 million

74.9 million

Fannie Mae

29.4 million

N/A

General Motors

27.2 million

N/A

Source: Yahoo! Finance.

Millions upon millions of these shares trade hands -- on a daily basis. Many of these transactions came from the big-money institutions or the short-term day-trading crowd. (Still, somewhere in there is the little guy.)

Today, some 18 months later, we want to again warn you about a stock -- just one, this time -- using the same thesis we used back then. The stock is AIG (NYSE: AIG  ) .

Why you should stay away
We believe there are better opportunities for the long term. Why? Because AIG has these frightening truths:

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.

In the two decades prior to its 2008 bailout, AIG ranked as an OpenSecrets.org "Heavy Hitter," meaning it was one of the top 100 political contributors of all time. The bailout was certainly more than a simple quid pro quo -- AIG had massive counterparty obligations, and its failure was a huge systemic risk -- but while that taxpayer money saved the company, 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. AIG also has a supra-constituency: the federal government.

That frightens us, because it's unclear how customers, shareholders, and employees will fare when a company has to do right by the Feds. That's no doubt one of the major reasons why TARP recipients like Citigroup, Bank of America, Wells Fargo (NYSE: WFC  ) , and Bank of New York Mellon (NYSE: BK  ) wanted to repay those government funds so promptly.

2. Scary financials.
Try to make sense of AIG's balance sheet, and you'll see massive amounts of debt and even more massive amounts of "other" liabilities. The company is trying to shore up its financial position by selling some units. As CEO Robert Benmosche said, "We remain focused on monetizing AIA and ALICO as quickly as possible in order to repay taxpayers, at values reflecting the unique strengths of these highly attractive franchises."

3. No near-term catalysts.
In April '09, we wrote that the financial companies would survive in some form -- our government had 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.

Buy one-foot bars
Heck, there may be value in AIG, but given its complexity, it is the proverbial "seven-foot bar" that Warren Buffett says he avoids in investing. (Buffett instead 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). But depending on what is still lurking on AIG's balance sheet, there may be a lot of value destruction in it as well.

Remember that avoiding losers is just as important as picking winners, especially since it takes a 100% gain to recover from a 50% loss. That’s why you should consider the three criteria above when it comes to AIG, and why you should sign up in the box below to get a free copy of "5 Red Flags -- How to Find the BIG Short," a new report from John Del Vecchio, CFA. Before coming to the Fool, John made his career helping hedge funds avoid losers in their portfolios -- and his free report can help you do the same. Sign up here:

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

Neither Tim Hanson nor Brian Richards owns shares of any companies mentioned. Ford is a Motley Fool Stock Advisor pick. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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