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When controversies crop up and stocks get taken to the woodshed, many investors immediately start asking if these beleaguered stocks have become great values. When such investors neglect to look up -- and ponder -- the record, they're riding for a fall.
Some companies in these situations are so fundamentally messed up, they're pretty much guaranteed value traps barring some miracle. Price isn't everything. Actually analyzing a company and how its management has historically behaved is one way investors can save themselves from some terrible and ultimately avoidable mistakes.
For years, it's been clear that Chesapeake Energy's (NYSE: CHK ) management and board have been, in a word, seriously bad news for shareholders. The fact that $12 million in shareholder money was utilized to buy CEO Aubrey McClendon's antique map collection to bail him out of financial distress in 2009 should have been a lesson no investor could possibly forget in ensuing years.
Even then, McClendon's behavior indicated a selfish CEO and a reprehensible board of directors that's looking out for their buddy the head honcho and not for shareholders. Today, more and more data is surfacing about the mind-bogglingly vast extent of Chesapeake's toxic problems.
My colleague Matt Koppenheffer said on May 2 that Aubrey McClendon needs to be ousted, after it came to light that McClendon was running a hedge fund and had taken loans against stakes he owned in company wells. That should have been enough to signal danger and turn off potential investors. And since then, even more heinous news has surfaced.
The SEC has started an informal probe into Chesapeake. Credit ratings agencies have downgraded their outlooks on the company. Even more recently, it's come to light that Chesapeake has troubling off-balance-sheet liabilities.
Still, sift through a financial newsfeed on Chesapeake over the course of the last couple of weeks and you will find some stock commentators bringing up the idea that Chesapeake has become a "value." One analyst even upgraded the stock...right before the SEC probe came to light.
This stock is not a value. It's simply vile.
Looking up the record
There's no shortage of companies with truly problematic issues that investors might interpret as "bargains" right now -- and should simply avoid if they're acknowledging the public record at all. Green Mountain Coffee Roasters (Nasdaq: GMCR ) has faced plentiful scrutiny from people like David Einhorn and Sam E. Antar about its accounting and the possibility it's been inflating its revenue numbers. The SEC's been looking into Green Mountain, too.
To make matters worse, Green Mountain's board recently jettisoned founder and chairman Robert Stiller for violating the company's own trading policies; a margin call triggered a sale during the restricted earnings period. Stiller's stake in the company was slashed by roughly half to 5.4%.
Apparently Stiller had used his shares as collateral for personal loans that were not of any particularly urgent personal nature, but rather to finance things like a 164-foot yacht and expensive real estate.
According to The Wall Street Journal, Stiller proclaimed that "lavish is all relative." I'm pretty sure long-term shareholders feel great about about such discussions of relativity, given the stock's "lavish" haircut over the last year as red flags have continued to crop up; the stock's fallen by about 66% over the last 12 months.
What about Groupon (Nasdaq: GRPN ) ? Before it had even gone public, red flags had already cropped up about its aggressive accounting methods. Were investors really surprised when it had to restate earnings right out of the gate? They shouldn't have been, and they shouldn't view it as a "daily deal" now.
There are better bargains emerging
Hopefully, few investors are looking into highly troubled companies like these as potential bargain stocks. I believe they'll get burned.
The truth is, the market's recent bearishness has been putting many strong stocks on sale, not because these companies have major fundamental problems with management, but simply because of macroeconomic fears. Those are the kinds of stocks long-term investors should be keeping their eyes on right now.
For example, both Starbucks (Nasdaq: SBUX ) and Costco (Nasdaq: COST ) have recently retreated from their 52-week highs, and neither has made any major operational blunders or shown signs of management malfeasance. In fact, I'd argue both companies have managements that may not always be perfect, but have shown a willingness to take accountability for mistakes.
Starbucks' Howard Schultz pulled off an amazing turnaround of his company, and acknowledged a heck of a lot of soul-searching he faced in the course of the troubles in his book Onward.
Costco's retired CEO Jim Sinegal built a solid history of bucking Wall Street's short-term demands to build a better business, and in 2007, he cut a check to the company for any gains he might have received from erroneously priced options. In other words, he took it upon himself to make things right. Sinegal and CFO Richard Galanti also later chose to give up bonuses and stock-option-related perks valued at more than $1.2 million. Our own Tom Gardner lauded this move in 2009, stating that it's "the epitome of stewardship -- taking full responsibility and putting shareholders first."
Hopefully, more investors will rethink the interpretation of true "value." Value doesn't necessarily follow a beaten-down stock price. Value comes along when a retreat in a price is disconnected from a company's strengths, not connected to a company's ongoing fundamental and ethical weaknesses. Meanwhile, the truest long-term values emerge from companies whose managements have values.
In other words, pattern recognition is just as important as stock price when it's time to ponder buying. When the pattern that emerges from a company's management is consistently ugly, investors should do themselves (and their portfolios) a favor, and stay the heck away.
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Check back at Fool.com every Wednesday and Friday for Alyce Lomax's columns on environmental, social, and governance issues.