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.

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.