5 "Buyer Beware" Stocks

The recent market rallies have stirred up a lot of optimism, although too much blind optimism is a mind-set that long-term investors would do well to avoid. It's pretty clear that with so many beaten-down stocks out there, many investors decided they "couldn’t lose" by picking up stocks that have been slammed. However, the market still offers plenty of overpriced, risky stocks, which means investors could lose.

I ran a screen on Motley Fool CAPS to try to determine some of the stocks that I think should have a "buyer beware" warning because of low CAPS community ratings, high multiples, and less-than-stellar balance sheets. I screened for stocks that have one or two stars, a price-to-earnings ratio higher than 20, and a low current ratio, which tells you how easily companies can pay off short-term obligations. You can run this screen yourself, but here are a few interesting contenders:

Company

CAPS Rating

P/E (TTM)

Current Ratio

Price Appreciation (6 months)

California Pizza Kitchen (Nasdaq: CPKI  )

*

37.3

0.5

110.7%

Brinker International (NYSE: EAT  )

*

22.8

0.7

149.8%

P.F. Chang's China Bistro (Nasdaq: PFCB  )

*

23.4

0.8

76.2%

Texas Roadhouse (Nasdaq: TXRH  )

**

20.0

0.4

101.5%

Cheesecake Factory (Nasdaq: CAKE  )

**

20.6

1.0

148.3%

All data from CAPS as of 5/20/09, except price appreciation data, which is from MSN Money.

California Pizza Kitchen is arguably the riskiest of these; it has the highest price-to-earnings ratio on the list and has among the lowest current ratios. Its stock has skyrocketed in a mere six months. Brinker International also looks pretty dicey, given the fact that it has a long-term debt-to-equity ratio of 128.2%.

Long-term investors should resist the temptation to pick up stocks that look "cheap." California Pizza Kitchen and Brinker both traded for about $5 or less at their 52-week lows, yet now sport relatively high multiples and don't have the pristine balance sheets that give an added measure of safety.

Go for the gold
Why buy "junk" food? It's not like there aren't some interesting restaurant stocks to contemplate. While I thought Buffalo Wild Wings (Nasdaq: BWLD  ) stock looked pricey lately, it does have a more compelling brand and growth story. Plus, its P/E is about on par with many of these names, at 25. More heartening, it has $44 million in cash and investments and no debt. (It rates three stars in the CAPS community.)

Meanwhile, McDonald's (NYSE: MCD  ) still looks like a compelling stock idea to me, given its leadership status in the fast-food segment, its continued business momentum as consumers pinch pennies, a healthy dividend, and a P/E of a mere 14. (The CAPS community has given McDonald's a solid four-star rating.)

Buyer beware
The market's recent rallies may have given many people a false sense of confidence, and it seems to me that in the case of many of the above stocks, investors have gotten downright gluttonous (and rather speculative). Although many investors and traders seem to think the worst is over and are snapping up stocks willy-nilly, there's plenty of economic data that show we still have plenty to worry about when it comes to the health of American consumers. Consumer-facing stocks still have plenty of time to find themselves on the losing end of this recession.

That's why it's more important than ever to be careful which stocks you buy for the long term; CAPS can help you find stocks that look appealing or risky. I think the best approach in these uncertain times is to search for leaders with plenty of cash and little or no debt. If you're lucky, they might even be trading at a discount to their peers. That's why many of the stocks I outlined above look downright unappetizing.

Do you disagree? Please, be my guest. Join more than 130,000 investors comprising the community intelligence on Motley Fool CAPS and let your opinion be known on these stocks and many more -- the more investors chime in, the better the community intelligence becomes, and that's good for all of us.

Buffalo Wild Wings is a Motley Fool Hidden Gems selection, and the Fool owns shares of it. Cut into any of our Foolish newsletters today, free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. The Fool has a disclosure policy.


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