The 2 Greatest Stocks I Will Never Buy

Most columnists will tell you to buy and hold "great" companies for the long term. Today I'm going to give you one crucial reason you should not blindly follow this advice.

Really?
Yes, really. I am a long-term investor, but I believe the great company concept has been oversimplified throughout the years, and I want to end that misguidance now.

What's a great company?
The word great is highly subjective, which means it can mean completely different things to different people. That's the first and most major flaw in the concept. What's great for me can be awful for you. This can be based on various tolerances for risk or differing investment timeframes.

In a minute, I will reveal two "great" companies I'm concerned about, one truly great company that I'm looking to buy, plus give you free access to four other outstanding companies that The Motley Fool itself owns.

Before we get to that, let's go review what I believe to be the No. 1 reason many investors and analysts mis-identify great companies.

Peak greatness
In 2001, best-selling business author Jim Collins published his oft-quoted Good to Great. It was the result of five years of research by his 21-person team, narrowing down some 1,400 companies to an elite 11 that had transformed themselves into great companies.

Collins picked several winners, but also two notable failures: now-bankrupt Circuit City and government-seized Fannie Mae. My intention isn't to speak ill of Collins, since I have the luxury of hindsight, but to highlight that in less than a decade, two "great" companies, as confirmed by years of research by almost two dozen people, became utter disasters for shareholders.

Why the great fell
In both cases, Collins' research period was applied when the companies were flying high. In 1995, Circuit City was the largest U.S. brand-name consumer electronics and appliance retailer, and Fannie Mae was the monopolistic mortgage king. However, both companies suffered irrecoverable falls because they didn't have strong long-term advantages in their industries.

Fannie Mae likely signed its death warrant in 1999, with its decision to ease credit requirements to borrowers with "slightly impaired" credit. Although politics were definitely involved in this decision, it illustrates the lack of advantage that Fannie had over the rest of the industry, thus putting it on a course for disaster less than one decade later.

In my opinion, Circuit City failed to survive the recession because of a lack of differentiation between itself, other brick-and-mortar retailers, and various online disruptors. The decision to lay off 3,400 of its arguably best salespeople further sealed the once-great retailer's fate . While Circuit City focused on cutting costs, Amazon.com focused on delivering goods as conveniently as possible.  

Great companies on My Watchlist
Using The Motley Fool's free stock tracker MyWatchlist.com, I've specifically got my eye on two companies that I think suffer from similar disadvantages to Circuit City and Fannie Mae. Neither of these stocks are going to zero, and I would never short them, but I'm concerned about their long-term growth prospects. Others deem them great, but I'm not so sure about them for my own investment dollars.

First up, Nintendo (OTC BB: NTDOY.PK), named the World's Best Company in BusinessWeek for 2009. The ingenious move to focus development dollars on the Wii's user interface gave the company a short-term advantage over rival Sony (NYSE: SNE  ) , which concentrated heavily on raw processing power and graphics. But Nintendo will soon face competition from unfamiliar directions.

One decade from now, I believe Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) will have directly led to or enabled Nintendo's fall from greatness. Apple led the way, showing consumers that they didn't need a dedicated gaming device when they could have an iPhone or iPad, and that a game didn't need to cost $50.

Meanwhile, Google's building an unbeatable (and free) platform in Android, which developers can extend and spread to every imaginable consumer electronic device. Why buy a dedicated Nintendo gaming device when you have a Google TV potentially running more than 100,000 apps?

The next company I'm watching is Coinstar (Nasdaq: CSTR  ) , the coin-sorting leader, which now gets 80% of its revenue from its movie rental brand, Redbox.

 


Coinstar's stock is up 93% over the past 12 months, which indicates that retail and institutional investors alike are using their buying power to extol these shares' greatness.

But I don't buy it over the long term. Given that Coinstar's namesake business has single-digit growth rates, and that Redbox is offering a commoditized and highly competitive product of recently release movies, I simply don't see the long-term greatness, despite the company's rapidly growing DVD segment.

In this space, I'd much rather invest in Netflix (Nasdaq: NFLX  ) , whose DVD rentals have primarily been "back catalog" or older movies. There are no other major players focused on older flicks, which allows the majority of the profits of old movies to flow Netflix's way, while Coinstar's Redbox dukes it out with massive companies like Amazon, Apple, and Google for new-release market share.

Don't get me wrong. I think Nintendo and Coinstar are great companies right now. I'm a consumer of both of their products, but the question is whether they can be sustainably great over the next decade or two. My bet is no. But we have a better choice ...

A truly great company for the long-term
I'm talking about Qualcomm (Nasdaq: QCOM  ) , which was identified by technology guru Eric Bleeker as the one company positioned to rake in the profits from the mobile device boom. Two simple lines from Eric's report sealed the deal for me:

Qualcomm has patented the technology behind every 3G data network in the world.

If you want to use a phone that can connect to a modern data network, Qualcomm is profiting.

That's the kind of long-term advantage I look for in a truly great company. I believe in the long-term growth of mobile data usage, and Qualcomm will unquestionably take advantage of that growth. Notice the stark difference between Qualcomm's position in their industry compared to Nintendo and Coinstar. The latter companies have a high potential for disruption, while Qualcomm's bulletproof patent portfolio ensures its longevity as a truly great company in an electrifying industry.

More outstanding companies
Qualcomm is one of the five companies highlighted in a new free report called 5 Stocks The Motley Fool Owns -- And You Should Too. Inside, you'll find Eric's masterful 1000-word write-up on Qualcomm, including the risks, plus four other stocks The Motley Fool owns. I invite you to get instant access to this indispensable free report by clicking here now.

Jeremy Phillips owns no shares of companies mentioned in this article.

Google is a Motley Fool Inside Value recommendation. Google is a Motley Fool Rule Breakers pick. Apple, Netflix, and Nintendo are Motley Fool Stock Advisor recommendations. The Fool owns shares of Apple, Google, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (34)

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 November 08, 2010, at 11:58 AM, Henry3Dogg wrote:

    It is hard to take seriously an investor writing an article under the title...

    "The 2 Greatest Stocks I Will Never Buy"

    ... since the basis of any investment decision is to compare the value the stock to the market price.

    Twelve months from now, what you thought of the stock now is, or should be, irrelevant.

  • Report this Comment On November 08, 2010, at 12:31 PM, BioBat wrote:

    I think it's wrong, in so many ways, to compare the Wii to an iPhone or iPad. It's apples and oranges in terms of what each does. One is a dedicated hardware device connected to your TV, the other two are portable.

    If you're going to compare, the proper comparison would be the portable Nintendo DS (which has games ranging from $5-$40) vs. the portable iPhone/iPad.

  • Report this Comment On November 08, 2010, at 1:52 PM, TMFMoby wrote:

    BioBat - Thanks for the comment. I could have done a better job there. I wasn't implying it was the iPhone/iPad vs. the Wii, but that meaningful competition would come multiple generations of devices from now, and that in the long-term, Apple has likely shifted the gaming model away from Nintendo's core.

    I'm suggesting this is potentially the tip of the iceberg for Nintendo in the long-term.

    Jeremy

  • Report this Comment On November 08, 2010, at 4:39 PM, shoemaker17 wrote:

    the great thing about red box is that all of their locations come with an unemployed, "t-shirt and jeans" movie critic. I usually don't use this feature, but I hear it usually has some pretty good picks.

    Also, with certain US coinage now having a melt value of more than what they are worth( pre-1982 penny equal to 2.6 cents, and nickel worth about 6 cents) do you think coinstar sorts these coins from the others?

  • Report this Comment On November 08, 2010, at 7:49 PM, bruce316 wrote:

    3G is obsolete. Re: Qualcomm

  • Report this Comment On November 08, 2010, at 8:13 PM, vidar712 wrote:

    I think you completely missed the point of your article in your recommendation of Qualcomm.

    (Based completely on what you have written,) Qualcomm is benefiting from the 3G network patents. But, over time, I would expect technology to shift away from 3G to something else (4G?). This will cause Qualcomm's patents will lose their earning potential. This is similar to how the technology shift you mentioned will hurt Nintendo.

    After you mentioned Qualcomm's 3G patents, you would have made your point by mentioning how Qualcomm is making developments for the future. (Working on patents for 4G networks or other technologies.)

    Listing Qualcomm's supposed strength as Nintendo's supposed weakness is just confusing to me.

  • Report this Comment On November 08, 2010, at 8:18 PM, zillatilla wrote:

    I see your point on these stocks, but I think you sell Nintendo short. They have a track record of innovation that keeps them ahead of the curve. Their new 3D gaming system is doing something that you can't do on a cell phone or an android device. Expect more innovation in controllers and visuals from a company with bulletproof intellectual property in Mario, Metroid, Zelda, etc.

    Nintendo is one of those companies, like Apple, that just understands what its customers wants and is capable of innovating.

  • Report this Comment On November 08, 2010, at 9:01 PM, bigkansasfool wrote:

    Circuit City failed because the pushy commission-based salesmen were very off-putting to customers, they had small stores that best-buy (meaning smaller selection), and they sold inferior goods.

  • Report this Comment On November 08, 2010, at 9:05 PM, TMFRhino wrote:

    Vidar712/bruce316,

    The same patents that made QCOM extremely strong in 3G transition to 4G at a slightly lessened royalty rate, they've already signed licensing contracts with most major companies for next generation.

    Also, 3G's far from dead. It'll be a complimentary technology with 4G networks for a long time, allowing a higher royalty rate on phones employing both a 3G and 4G radio. More on this can be read here:

    http://www.fool.com/investing/general/2010/10/15/the-real-wi...

    Best,

    Eric Bleeker (TMFRhino)

  • Report this Comment On November 08, 2010, at 9:08 PM, 72demon wrote:

    +1 on Vidar712's comment....thats what I was thinking....3G, so what, whats next?

  • Report this Comment On November 08, 2010, at 9:15 PM, bigkansasfool wrote:

    "In this space, I'd much rather invest in Netflix" - It's interesting that the author has succumb to the same folly the author pointed out in Collin's research. Netflix, with it's 64 P/E, doesn't make for a good long-term investment unless it turns out to be that 1/1 million stock like early walmart. I say this as an avid Netflix user, I would not purchase the stock because it would have to create amazing growth for a long period to justify that valuation. I want great companies with large moats for great prices (but I'll take fair prices if I have to ;) ).

  • Report this Comment On November 09, 2010, at 4:49 AM, langco1 wrote:

    a stock no one should even consider buying the bankrupt disgrace GM.

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