When "Value Stocks" Are Simply Vile

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.

History repeats
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."

Redefining values
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.

Alyce Lomax owns shares of Starbucks. The Motley Fool owns shares of Costco and Starbucks. Motley Fool newsletter services have recommended buying shares of Starbucks, Green Mountain Coffee Roasters, Chesapeake Energy, and Costco, as well as creating a lurking gator position in Green Mountain Coffee Roasters and writing covered calls on Starbucks. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (6) | Recommend This Article (15)

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 May 11, 2012, at 3:41 PM, sikiliza wrote:

    I am betting on CHK getting past this through a combination of urgent Board action (fire McClendon) and the fact that Natural Gas will rebound. My current play right now (which might end up being a JPM) is picking up long dated deep in the money calls at a song.

  • Report this Comment On May 11, 2012, at 7:23 PM, earthunit wrote:

    Another slanted, short-helping GMCR article.

    What stupid non-GMCR related investing was done by GMCR's ex Chairman has no relevance to the fact that Americans are drinking kcups by the bucket loads and they LOVE them.

    GMCR can and will easily overcome any temporary distractions and over-supply.

    COFFEE does not become obsolete like PCs!

    And BTW, regarding Einhorn, the NY Mets were smart enough to get rid of that hedge fund crook.

    How's his $11 million UK fine doing, for INSIDER trading??!

  • Report this Comment On May 12, 2012, at 2:14 PM, CoreAndExplore wrote:

    This article may as well have come out of the WSJ opinion page. Where's the analysis to back up the author's claims?

    The following is a strange comment considering the lack of fundamental analysis in the article and the highly profitable and solvent companies used as examples of value traps:

    "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."

    Please tell me what fundamental weaknesses each of these companies currently exhibits. Please tell us how each of these two companies' business prospects will be materially affected by recent developments.

    Each company certainly has some short to mid-term headwinds: GMCR's obviously has to do with the expiration of a patent on K-cups (which has already been priced into the stock, and then some), whereas Chesapeake will need to come to account for its off-balance sheet liabilities, make some management changes (including CEO), and shore up its immediate financing needs. However, GMCR has a strong and growing business, and like it or not, so does CHK. When investors realize the strength of GMCR's customer loyalty after the patent expiration, and CHK's diversification into more profitable liquid fuel sources, including NGLs, goosing profits as natural gas prices rebound, shorts will get squeezed to death. Are either of these companies good short-term bets? Heck no. Are either of these good long-term investments? Maybe, maybe not, but I certainly wouldn't write them off the way this writer is apt to do.

  • Report this Comment On May 13, 2012, at 4:45 PM, Synchronism wrote:

    @ coreandexplore

    If I were you, I'd stop expecting TMF writers to be as in-depth as you'd expect, especially the ones working on the free articles.

    The free articles are usually there to prove a point, although those that happen to bash a company or extol it are often made on the basis of "quickies" that do away with useful knowledge by relying on a third-party info provider like capitaliq and mere skimming of the fundamentals.

    I've gotten my hands on some premium articles awhile back. While more substantial and useful, they are nonetheless too incomplete for my standards and are better off being treated as high-level screeners and reliable citations than actual analyses.

    TMF analysts do know their stuff (I know one and I was once a candidate for a position), but the "conflict of interest" lies on the fact readers hate the stuff that are undeniably more useful to a professional or an unusually sophisticated retail investor...

  • Report this Comment On May 15, 2012, at 11:50 AM, TMFLomax wrote:

    Thanks for the feedback; this article is about assessing management quality and how I sincerely believe that has an impact on the long term (and IMHO, investors who don't look up the record on management behavior are also merely "skimming" on their research). I think some of us may disagree on what is "in-depth" research.

    I have existing thumbs down underperform calls on CHK, GMCR, and GRPN in Motley Fool CAPS, so we can track over the long haul whether my opinions on these stocks will prove correct or not. As of this writing, all three of these calls have been successful in CAPS points (+16.87, +89.74, and +55.38, respectively). I only wish I had made the call earlier on CHK, since like I said, the management issues have been quite apparent for years. That was an oversight on my part; check out its 5-year chart.

    Best,

    Alyce

  • Report this Comment On May 15, 2012, at 6:02 PM, Synchronism wrote:

    Indeed it is. Actually, I was wondering where you usually find the information on management behavior, like those you described in this article.

    As of now, I gauge management by looking for news articles about the company, seeking very specific information on annual reports, and well, listening to conference calls scrutinizing their responses and tones of voice (which transcripts on SeekingAlpha can't give you!) WHILE amusing myself from any stupid questions asked by the analysts. Other than that, I'd try looking for figures concerning BOD meetings, but considering I've sought information on that for three US-listed companies already and failed to do so, it's starting to look like something not required by the American SEC.

    As for the definition of "in-depth", I imagine myself as a sniper in the investing biz (in fact, I prefer sniper rifles when playing videogames), so I tend to take about one to two weeks' worth of work scrutinizing a company and its business economics. Obviously, my philosophy of "in-depth" is far more exaggerated than your typical retail investor...

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