Beware of These 5 Dangerous Stocks

It really doesn't matter whether you consider yourself a value investor, a dividend investor, a growth investor, or something else entirely -- the fact is, we investors like companies that grow.

Sure a deep-value investor might consider investing in a company that's stuck in neutral, but we're almost always going to prefer a company that will put more profit in our pocket next year than it did this year.

But not all avenues to growth are made equal. The ideal growth scenario is a company like Intuitive Surgical that has a hot product and is driving growth by simply wooing new customers and selling more of its surgical systems and related equipment. Intuitive Surgical acquired Computer Motion back in 2003, but the company has had no need to bother with M&A since then.

Another way up
Intuitive's situation is what's usually referred to as "organic growth" -- that is, a company generating a growth internally. But organic growth isn't the only way that a company can keep its results heading northward.

When a company's internal growth begins to slow, it will sometimes hit the acquisition trail to reinvigorate its growth. Sometimes this can work out quite well, as in the case of Oracle (Nasdaq: ORCL  ) . Over the past five years alone, the company has made about 60 acquisitions, which helped drive a doubling of its per-share profit.

I suspect that a lot of Oracle's success has come from CEO Larry Ellison's Sun-Tzu-inspired hard-driving approach to business and M&A. Oracle famously took over PeopleSoft in an acrimonious hostile takeover. Other CEOs are generally clubbier with their acquisition targets and end up paying hefty take-out premiums that make the deal unattractive.

The last chapter hasn't been written on Oracle, but Ellison seems to have shown that being a serial-acquirer doesn't have to be a kiss of death.

Not always that way
In fact, it's usually not that way. Rather than an actual strategy, acquisitions often end up a desperate ploy to appease shareholders' thirst for growth. Worse, the accounting involved in integrating acquisitions can provide a smokescreen for corporate managers that are up to no good.

A perfect example is the experience of Tyco (NYSE: TYC  ) a decade ago. Under the leadership of CEO Dennis Kozlowski, the company made more than a hundred, pushing the growth pedal to the floor and clocking nearly 600% revenue growth between 1996 and 2001.

But the wheels started coming off in 2002. A mounting debt load started to become an issue, a $9 billion loss piled up, and Kozlowski resigned under scandalous accounting circumstances. The stock plunged, the company muddled along, and eventually ended up splitting itself up into Tyco, Covidien, and Tyco Electronics.

Your chance to score
Not all highly acquisitive companies end up revealing the kind of underhandedness that went on at Tyco, but many of them do end up tripping over themselves in the rush to pile on acquisitions and the result is investor disappointment and a stock sell-off.

Now you have a choice: You can watch this go down from the sidelines, or you can beat the rest of the market to the punch and profit from the ride down. That's right, I'm suggesting that investors consider getting short.

Tracking down targets
When one company acquires another, the purchase price typically exceeds the target's book value. Accounting rules require that the premium be accounted for, so the acquiring company has to add to its goodwill and intangible balance sheet.

So if we're trying to track down companies that have been gobbling up acquisitions, intangible assets are a good place to start. The companies below all had a significant amount of their balance sheets tied up in intangibles and saw sizable growth in their intangible balance over the past couple of years.

Company

Total Intangibles

Intangible Assets as a Percentage
of Total Assets

3-Year Intangible
Growth

Pfizer (NYSE: PFE  )

$101 billion

53%

131%

Abbott Labs (NYSE: ABT  )

$24 billion

46%

62%

Danaher (NYSE: DHR  )

$13 billion

65%

52%

CenturyLink (NYSE: CTL  )

$12 billion

52%

190%

Ingersoll-Rand

$11 billion

56%

148%

Source: Capital IQ, a division of Standard & Poor's.

The common thread through all of these companies is that they all operate slow-growth industries.

Both Pfizer and Abbott Labs are already large, lumbering companies, so it takes a lot to move the growth needle. In the pharmaceutical world, research and development on a new drug can take a heck of a long time and that only dumps the company into the drug-approval waiting room. Many of the pharmaceutical giants have looked to acquiring small biotechs with novel drugs and consolidating other large pharma players for their growth.

In 2009, Abbott snapped up a number of companies including Advanced Medical Optics for $1.4 billion and Solvay Pharmaceuticals for $6.2 billion, while Pfizer completed the huge takeover of Wyeth for roughly $68 billion.

CenturyLink is in an even more precarious position than the pharma giants. Much to the chagrin of the government and consumers, health-care spending continues to grow. Spending on land-line telephone service does not. To try and bring some life to its business, CenturyLink spent $6.1 billion to acquire Embarq in 2009. More recently, the company got the nod from its shareholders to complete the $10.6 billion takeover of Qwest Communications (NYSE: Q  ) .

Finally, both Danaher and Ingersoll-Rand are diversified industrial manufacturers that have relied for a long time on using acquisitions to continue to log growth. In fact, Danaher very explicitly points out the importance of acquisitions in its Securities and Exchange Commission filings: "Our ability to grow at or above our historic rates depends in part upon our ability to identify and successfully acquire and integrate companies and businesses at appropriate prices and realize anticipated cost savings."

Ready, Set ... Do more research!
I certainly don't think all of the companies above are advisable short targets -- in fact, I own shares of Abbott Labs. However, all need to be watched closely by investors because relying on acquisitions for growth can be a very tricky road to walk.

But if you want my two cents on which of those companies is most likely to yield to short-sellers, I'd say CenturyLink. The company operates in a dying industry and it has taken on considerable debt as it acquires other companies whose business is largely headed in the same direction.

Of course these aren't the only serial acquirers out there, and this is not the only way to find potential short targets. Forensic accountant, fellow Fool, and short-selling expert John Del Vecchio, CFA, recently put together a report -- "5 Red Flags -- How to Find the Big Short" -- that reviews five key red flags that can help identify short-able stocks. To get your hands on a free copy of John's report, just enter your email address in the box below.

Fool contributor Matt Koppenheffer owns shares of Abbott Laboratories, but does not own shares of any of the other companies mentioned. Covidien and Pfizer are Motley Fool Inside Value selections. Intuitive Surgical is a Motley Fool Rule Breakers pick. The Fool owns shares of Oracle. 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 Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (10) | Recommend This Article (43)

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 September 13, 2010, at 6:12 PM, tmjb100 wrote:

    Hey guys, I think that you're being a foolishly bit nuts to put Abbott Laboratories in a group of candidates for short selling. Historically, Abbott has made relatively small acquisitions compared to its overall net worth, and those were product strategic acquisitions. Moreover, Abbottt runs its business with its executives' noses to the grindstone and keen eyes on the bottom line. I've owned Abbott stock through both good times and bad and they've rarely disappointed me.

  • Report this Comment On September 13, 2010, at 6:52 PM, TMFKopp wrote:

    @tmjb100

    Thanks for reading and for the comment.

    As I note in the article, an acquisitive history is just a starting point for finding short candidates. I actually own Abbott myself, but growing through acquisition can be a very tricky endeavor so even companies that I like (like Abbott) get an extra close eye on them if M&A is a significant part of their strategy.

    Matt

  • Report this Comment On September 13, 2010, at 11:10 PM, owlbert wrote:

    When you think of "serial buyers" in the software business, just look back to Charles Wang of Computer Associates who wrote the book on that business model.

  • Report this Comment On September 13, 2010, at 11:11 PM, TMFKopp wrote:

    @owlbert

    Absolutely! That is a perfect example of the type of company we're worried about here.

    Matt

  • Report this Comment On September 14, 2010, at 6:39 AM, FiveHappyDaze wrote:

    Today we have a generation of 78 million aging baby boomers living with the dread fear that someday they'll lose their marbles and ending up locked in an Alzheimer's care facility.

    According to one survey the fear of Alzheimer's runs so deep - boomers are twice as afraid of Alzheimer's as they are of death itself!

    So it's only natural that these legions of aging souls would be hoping and praying that a cure for Alzheimer's disease would soon be found.

    They're betting that someday soon scientists will come up with a quick fix, a pill or an injection of some sort that will restore youthful function to their aging brains.

    Sadly that day will never dawn. There will never be a cure for Alzheimer's disease! Not now, not ever!

    How I can say this with so much confidence? I can be certain because I've read the research. Sadly the brain damage that causes Alzheimer's is permanent and irreversible. No drug is ever going to breathe new life into dead brain cells.

    For that same reason there will never be an effective treatment either. Once again, how could any treatment hope to bring dead brain cells back to life?

    Wall Street Skullduggery

    The fact that Alzheimer's brain damage is permanent doesn't stop Wall Street from periodically promoting new drugs each promising to be the final cure for Alzheimer's.

    The most recent example is a drug called Dimebon. It's a Russian antihistamine medication that seemed to help elderly Russians reverse their age-related memory problems. Russian doctors reported startling memory improvements in their elderly who used the antihistamine.

    Early animal studies were encouraging and the thought of a simple over-the-counter cold medicine curing Alzheimer's had Pfizer's management drooling in greedy anticipation.

    Wall Street boldly trumpeted the news that soon we would have a solution to the burgeoning Alzheimer's epidemic. Pfizer's stock surged on the news. But fell again several years later when the final research results proved that Dimebon was no more effective than aspirin!

    More recently on August 17, 2010 Eli Lilly halted clinical trials of their newest Alzheimer's drug semagacestat when it was found that far from improving the memories of study subjects, the drug actually worsened subjects' ability to think, recall memories and perform activities of daily living. Of course, Eli Lilly's stock tumbled on the news.

    You can expect to see many more such drugs in the future and you can also expect that in each case the drug involved will prove completely worthless. Sadly, the snake-oil peddlers are still with us.

    Now for some welcome good news: though we'll never have a cure, nor will we ever come up with an effective treatment, scientists have made a major discovery that will forever change how we view age-related memory loss and Alzheimer's disease.

    Medical researchers working at some of the most respected research universities in the world have at long last isolated and identified the real root cause of age-associated memory loss and Alzheimer's disease. Armed with this new information it's now possible for anyone to safely and effectively prevent age-related memory loss and Alzheimer's disease without drugs or surgery.

    ----------------------------------

    Money without intelligence is like a car without a road.

    http://www.intelligentinvestingtips.com

  • Report this Comment On September 14, 2010, at 7:18 AM, sagitarius84 wrote:

    I would take the other side of a short trade anytime on Abbott (ABT).

    http://www.dividendgrowthinvestor.com/2010/03/abbott-labs-ab...

    Full Disclosure: Long ABT

  • Report this Comment On September 16, 2010, at 4:10 AM, Latinus wrote:

    FiveHappyDaze wrote:

    Armed with this new information it's now possible for anyone to safely and effectively prevent age-related memory loss and Alzheimer's disease without drugs or surgery.

    -

    Please tell us how.

  • Report this Comment On September 20, 2010, at 3:56 PM, ODorney wrote:

    Unfortunately, Matt scared me enough to sell my 800 shares of CenturyLink at $36.52 at the open on 9/14. Today, just days later it's $39.39. Guess I learned a $2,000 lesson the hard way. In the future, I'll stick with my own gut feelings.

  • Report this Comment On September 20, 2010, at 11:10 PM, TMFKopp wrote:

    @ODorney

    First of all, I truly hope that more goes into your investment decisions than a single article.

    Past that, though, you're reading the wrong site if you're expecting to read about what will impact shares over a period of days. Most writers and community members at The Fool are long-term investors and are looking at least months, if not years, down the road when they talk about expected performance of a company or stock.

    That, of course, doesn't mean that I won't be wrong on occasion. Any investor, adviser, journalist, or analyst that tells you they're right 100% of the time is lying through their teeth.

    Matt

  • Report this Comment On September 28, 2010, at 6:58 AM, MFMerlin wrote:

    FiveHappyDaze was pretty vague and baiting with his final comment re Alzheimer's and honestly I nibbled a little and briefly on the link he attached (not useful), however he may be referring to some work being investigated on the use of low dosage lithium orotate as reported in Lancet journal.

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