This Future Was Completely Predictable

Now that Blockbuster has formally declared bankruptcy, one of the first questions you should ask yourself as an investor is "Could I have seen that coming?" And the answer is a resounding "Yes!" For at least four years, the death of Blockbuster's shares was completely predictable.

Similarly, it was pretty obvious that the old General Motors was on a collision course with oblivion years before it finally gave up the ghost. With clairvoyant foresight, you could have shorted either stock and made a nearly 100% return in just a few years. Not bad, especially for fates that looked pretty much inevitable, even back then.

Can you try this at home?
Every once in awhile, a business' failure takes investors by surprise. Enron, for instance, looked like a healthy company until it was revealed that a huge swath of its business model was a scam. But quite often, the signs of impending doom are apparent long before the bankruptcy court gets involved. If you learn what to look for, you can get a sense of who's at risk of being the next corporate shoe to drop.

There are hree key factors that, when found in combination, will often tip you off to such troubles:

  • A lousy balance sheet: Negative equity usually means either that the company routinely hemorrhages cash or that it made some huge -- and lousy -- investments.
  • Regular losses: If the company routinely can't turn a profit, it simply won't stay in business for long, no matter how whiz-bang its products may be.
  • Substantial business risks: If the market has made a company's product irrelevant or uneconomic or if its industry routinely produces failures, a company with the other two factors simply may not have the flexibility to adapt and survive.

If you look for companies with all three factors working against them, you may wind up with a list like this:

Company

Shareholder Net Equity (in millions)

Net Income
(in millions)

Business Risk

UAL
(Nasdaq: UAUA  )

($2,756.0)

($106.0)

The airline industry is prone to bankruptcies, and UAL has itself declared it in the past.

Taubman Centers
(NYSE: TCO  )

($351.7)

($61.7)

Heavily dependent on mall shoppers. Online retail, discount chains, and a bad economy work against it.

Incyte
(Nasdaq: INCY  )

($104.8)

($164.5)

Research-based biotech is often "feast or famine" -- either wild success or absolute failure.

ArvinMeritor
(NYSE: ARM  )

($946.0)

($28.0)

The auto industry and its suppliers are prone to bankruptcies -- GM, Chrysler, Dana, etc.

Rite Aid
(NYSE: RAD  )

($1,933.8)

($562.9)

Heavy debt load, dependent on single wholesaler for all brand-name prescription drug sales.

Warner Music Group
(NYSE: WMG  )

($228.0)

($115.0)

Legal and pirated online music distribution reduces its control over pricing.

Playboy Enterprises
(NYSE: PLA  )

($27.6)

($35.2)

Easy to substitute free online alternatives for many of its products.

Financial data from CapitalIQ, a division of Standard & Poor's, as of Sept. 29.

Now, not every company on that list is certain to fail. Food and Drug Administration approval of a new product could cause Incyte's business to shine and its shares to skyrocket, for instance. But when lousy financials meet a tough industry -- like in UAL's and ArvinMeritor's cases -- supreme caution is certainly warranted.

And when new distribution channels make a company's model cost prohibitive, then you've got a situation that pretty much mirrors what happened to Blockbuster. Without substantially reinventing themselves -- and doing so quickly, given their balance sheet weakness and earnings shortfalls -- how exactly can Warner Music and Playboy survive?

Polish your crystal ball
It's fairly difficult to figure out where the "next big thing" that sets the world on fire will come from. Once that next big thing appears, however, it's a lot more straightforward to figure out who's likely to get run over by it. And that'll give you enough predictive ability to know which companies to either avoid or perhaps even consider selling short.

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.

At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (8)

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 30, 2010, at 2:47 PM, gorlickg wrote:

    Rite aid is a little filly that can break your heart.

    Always had too fat a jockey.

  • Report this Comment On September 30, 2010, at 6:09 PM, HectorLemans wrote:

    Remember survivorship bias also works in reverse. Some other companies I could have shorted years ago because it was so obvious they were headed to zero: Sirius Radio, Citigroup, Crocs, Ambac and E*Trade.

    One small problem...none of them are at zero

  • Report this Comment On October 01, 2010, at 12:03 PM, ChrisFs wrote:

    If it were completely predictable, they would be a lot more rich people.

  • Report this Comment On October 01, 2010, at 1:22 PM, georacer wrote:

    going short on playboy when they are getting multiple offers above the current share price to go private might not be a great idea.

  • Report this Comment On October 11, 2010, at 3:48 PM, ChrisBern wrote:

    Barnes and Noble seems to fit this bill right now. They've wasted money trying to compete in the ultra-competitive e-reader business, and it seems like they'll befall the same brick-and-mortar issue that allowed Netflix to dispose of Blockbuster. (in B&N's case, amazon is the prime enemy)

  • Report this Comment On October 14, 2010, at 7:40 PM, TaubmanIR wrote:

    I read your "The Future was Completely Predictable" post with interest and must point out that the comparison of Taubman Centers (NYSE:TCO), a Real Estate Investment Trust (REIT), with non-REITs is flawed. As a REIT, we (and the investment community) focus on Funds From Operations as the supplemental measure of performance, which adds back real estate depreciation to net income. The reason that FFO is important for a REIT is that accounting depreciation doesn’t reflect the economics of real estate assets. Our balance sheet is viewed as “conservative” with our solid interest coverage ratios and market capitalization ratio of 47 percent as of June 30. Finally, with respect to business risks, as the U.S. economy has improved, the sales of the tenants in our malls have recovered smartly -- up 11.4% through June. The regional mall continues to prove its resiliency and its unique value proposition to retailers and shoppers in good times and bad.

    Barbara Baker – VP, Investor Relations, Taubman Centers

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