For more tales of financial frights, our Halloween special series, Avoid These 8 Investing Horror Shows, won't disappoint!
"Oh! No mortal could support the horror of that countenance. A mummy again endued with animation could not be so hideous as that wretch. I had gazed on him while unfinished; he was ugly then, but when those muscles and joints were rendered capable of motion, it became a thing such as even Dante could not have conceived."
-- Frankenstein, by Mary Shelley
Isn't it fun to build the perfect beast? Start with Joe Montana at quarterback, Barry Sanders as tailback, and Rod Tidwell in the slot receiver position, and you have the makings of a truly great imaginary football team. Start a band with Eric Clapton, Ginger Baker, and Jack Bruce, and you'd get an awesome rock-funk-jazz combo. Oh wait, that actually happened.
Do the same thing with stocks, and you could learn something about your own investing style. Wouldn't you love to get the fanatical customer base of Apple (Nasdaq: AAPL ) at the rock-bottom valuation of Seagate Technology (Nasdaq: STX ) ? Perhaps you'd rather start with a truly great management team and throw them into a different industry with more growth ahead of it. Your choices will say a lot about how you think when building your portfolio.
In the Halloween spirit, let's do the opposite today: We're about to build a real monster stock out of the worst parts of a few different companies. If nothing else, you should know that it's time to run the other way when you see these scary body parts approaching. You might even find some great short-selling ideas.
Start with the head
Great stocks always come from great businesses, as you're actually buying a share of the company with your investment. That's why I would be terrified to be stuck with a rudderless ship like Conexant Systems (Nasdaq: CNXT ) .
The company is still proud of its fax modem products in an age of gigabit fiber optics and always-connected smartphones, hasn't updated its investor relations site in ages, and has fired the vast majority of its research staff in the last three years. The lights are home, but nobody is on. This is the closest thing you'll ever see to a zombie business stalking Wall Street for some fresh braaaaaiiiinssss. Don't let it be yours.
Then, the body
Every monster needs a thick, meaty body full of muscles with which to bash its victims into a bloody pulp. For the perfect beast, I'd be looking for a great balance sheet full of muscular cash. In this case, I'm going for the opposite of that. Bare-bones balance sheets can be scary all by themselves, but become truly haunting when paired with high debt balances and an expensive habit of burning even more cash. Say hello to my little friend, Rite Aid (NYSE: RAD ) .
The drugstore chain has almost no cash in the bank but more than $6 billion of long-term debt, is in the habit of burning cash quarter by quarter, and hasn't reported an annual profit since 2007. Rite Aid is not a zombie, but a giant blob of monstrous debt that's threatening to suck itself into a black hole of inescapable financial doom at any moment. It reminds me a lot of Blockbuster, which recently did pass on to that ghastly afterlife of bankruptcy protection.
Run. Hide. Don't look back.
Next, I'm going to rip out the precious lifeblood that keeps every respectable company running. Wireless broadband operator Clearwire (Nasdaq: CLWR ) is the poster boy for hideous cash-burning habits, reporting $3.2 billion of negative free cash flow over the past 12 months on just $378 million in revenues. How is that even possible?
The company has a powerful consortium of financial backers but only one credible customer in Sprint Nextel (NYSE: S ) , and it doesn't look like the partnership with the third-largest wireless service provider is good enough to make a real business out of Clearwire. With more than $740 million of annual cash burn in the books before investing $2.5 billion of borrowed dollars in network infrastructure, it will take a miracle to get this bird off the ground. And the burning ichor of deeply crimson negative cash flows is the perfect antiblood for my wondrous Frankenstock.
Beauty is only skin deep
How scary is all of this nasty stuff if you're not paying too much for it? That's where cancer drug developer Dendreon (Nasdaq: DNDN ) comes in, flapping its beautiful dreams of a cancer-free world to excite investors and then leaving them high and dry with not much to show for their investments.
I'm all for curing cancer, and Dendreon may be on its way there after clearing prostate cancer treatment Provenge with the FDA. But patient uptake has been slow due to the astronomical cost of the treatment, and Medicare hasn't decided whether it's going to foot the bill for all potential patients to get the treatment.
For this risky business, investors are paying (make sure you're sitting down with a defibrillator handy):
- 8.5 times Dendreon's book value.
- More than 1,800 times trailing sales.
- 40% more than they would have paid a year ago.
Price-to-earnings or cash flow valuations are meaningless because Dendreon is negative on both counts. Everything could work out for Dendreon, but there's also a real risk of getting nothing back from this investment if things crawl to the south. That's the kind of sky-high, risky valuation I'd want on a stock given to my worst enemy.
There's my perfect monster stock: the leadership of Conexant, the balance sheet from Rite Aid, cash burns of Clearwire's caliber, and the high-risk valuation of Dendreon. Put all of this together and you might as well burn your cash on a funeral pyre instead. Just one of these components should be enough to send investors into a cold sweat at night.
How would you compose the worst stock in the world? Get horribly creative in the comments below.
Looking for additional scary stories? We've got what you need in our Halloween special series, Avoid These 8 Investing Horror Shows.