One Stock to Sell Today

The "dash to trash" market we've had this year is coming to an end, so don't be the last one out the door -- or the last one in.

Enterprising investors who took a chance on stocks the market was essentially leaving for dead in March, like Ford Motor (NYSE: F  ) , Citigroup (NYSE: C  ) , and Fifth Third Bancorp (Nasdaq: FITB  ) , have been handsomely rewarded. At their lowest points, these companies traded for around $1, and though each of them has rallied largely on the belief that the worst is behind us, it does not mean they are ideal places for new money going forward.

In fact, lower-quality companies are the last place you want to be putting money right now; if you own one, now's the time to consider selling and bank your profits.

Whatcha gonna do with all that stuff?
Based on Standard & Poor's data that ranks domestic equities on earnings and dividend quality, it's apparent that the lower-quality stocks that have carried much of this rally are not only pricey but are also running out of steam.

Consider:

 

Grade "C" Stocks

Grade "A" Stocks

Returns, Jan. 1 through April 30

30%

(5.7%)

Returns, May 31 through July 27

9%

7.0%

Price-to-earnings ratio

50.6

16.0

Source: S&P data, as reported in The New York Times on Aug. 1, 2009.

The small-cap-tracking Russell 2000 index has returned more than 60% since March 9, but has been similarly buoyed by lower-quality companies. Indeed, it has been companies that had negative profits in 2008 that surged early and look quite expensive today.

 

Negative net income (2008)

Positive net income (2008)

Number of companies

732

1,277

Average returns, March 9 through May 9

128.9%

67.8%

Average returns, May 9 through Aug. 4

25.9%

12.9%

Price-to-book

3.6 times

2.5 times

Data provided by Capital IQ, a division of Standard & Poor's, as of Aug. 4, 2009.

As you can see from both tables, higher-quality companies have been closing the performance gap in the past few weeks. I'll give you one quality name to consider buying in a moment, but first here's more on that stock to sell today that I promised in the article's title.

Reading is fundamental-ly changing
Earlier this winter, Borders Group (NYSE: BGP  ) CEO Ron Marshall must have felt like Custer at Little Big Horn, surrounded on all sides by increasing competition, emerging technology, heavy debt, and a seismic shift in consumer behavior. Marshall was thrust into his current role in January, replacing outgoing CEO George Jones following an unacceptable 11.7% drop in holiday sales for the already struggling bookseller.

Unlike Custer, though, Marshall had some reinforcements -- in the form of activist hedge fund Pershing Capital Management, Borders' largest shareholder, which in February agreed to extend the terms of an already juicy loan agreement through April 15.

At first, the market remained unimpressed and sent Borders' shares as low as $0.39 per share on March 6. Then, on March 30, with the market showing signs of some improvement, Pershing agreed to a full-year extension of the previous agreement, but this time on even better terms -- that is, for Pershing, not Borders.

Since that new agreement was forged, Borders shares have surged 543% to almost $4.00 per share behind a more forgiving market, some massive inventory reductions, debt repayments, and cost-cutting. Needless to say, Pershing's made out pretty good on the new deal so far, but Borders isn't out of the woods yet.

While Borders has been trying to just stay a going concern, the bookselling business has changed dramatically, moving away from the bricks-and-mortar storefront and into the digital world. Right now, e-books only represent a fraction of total book sales, but are expected to move from $323 million in 2008 sales to $9 billion by 2013, according to the research firm In-Stat.

And competition in this burgeoning market is coming from some pretty big fish, namely e-book reading equipment offered by Amazon.com (Nasdaq: AMZN  ) and Sony, as well as its traditional competitor, Barnes & Noble, which is now offering a library of e-books for use on the Apple (Nasdaq: AAPL  ) iPhone and Research In Motion's (Nasdaq: RIMM  ) BlackBerry smartphone. With its still-frail financial health, it's unclear that Borders will be able to sustainably compete with these more efficient larger businesses.

The bottom line for investors remains whether Borders will be able to pay back Pershing's extended loan by next April. Pershing will likely continue to throw Borders a lifeline as long as the turnaround remains on track, but if this holiday season's sales are anything like last year's, it isn't a foregone conclusion. And without Pershing's support, Borders is in real trouble.

For my money, overreliance on an activist hedge fund is not a risk I'm willing to take. If you've enjoyed significant gains in Borders over the past few months, it is the one stock to sell today.

Foolish bottom line
This recent stock market rally has been largely fueled by lower-quality companies, especially in the small-cap arena. Borders is just one example of this phenomenon.  As investors once again turn their attention to quality companies, it pays to find those that are:

  • Small.
  • Underfollowed.
  • Financially strong.
  • Well-managed.
  • Dominant in their market niche.

That's why co-advisors Seth Jayson and Andy Cross use these very criteria to pick out stocks for Motley Fool Hidden Gems members. After all, it stands to reason that the best stocks of the next 10 years will also possess these traits.

One stock the team feels fits the profile is Brink's Home Security, provider of home security systems to more than 1.3 million customers. The recent spinoff from The Brink's Company has a strong balance sheet, positive free cash flow, and a high level of recurring revenue.

To learn more about the Hidden Gems portfolio, a free 30-day trial is yours. Simply click here to get started.

Already subscribe to Hidden Gems? Log in at the top of this page.

Fool analyst Todd Wenning hopes you're enjoying your summer. He has no financial interest in any stock mentioned. Apple and Amazon are Stock Advisor selections. The Fool owns shares of Brink's Home Security and has one wicked disclosure policy.


Read/Post Comments (7) | Recommend This Article (29)

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 August 13, 2009, at 2:11 PM, EditorJim wrote:

    With Borders, I had initially praised the $200 million in debt repayment after 2008 Q4, but now I realize that it wasn't cost-cutting and cash flow that allowed them to achieve this as much as it was the inventory reduction that essentially transferred their revolving credit with suppliers to long term debt holders. That's not a trick you can pull 2 years in a row, and with the lower sales that will naturally result from using their seedstock like this, they're playing a risky game. Any miscalculation and they'll get a cascade of store closures with associated costs that will make further debt reduction next to impossible. Look at Q2 sales (reporting soon). If it's another double-digit drop like Q1, there will be a lot of pressure to streamline store locations to reflect a permanent drop in gross revenue.

  • Report this Comment On August 13, 2009, at 4:32 PM, Varchild2008 wrote:

    (F) is pricy? uhm... no..

    $8.00 a share for (F) Ford means the company is CASH NEUTRAL.... No profit.... No loss...for the quarter.

    Below $8.00 = Loss....

    Above $8.00 = Gain....

    Since I believe in Alan Mullaly's 2011 target for profitability it simply makes perfect sense to come in and scoop up more shares of (F) as much as I have the money to do so whenever it dips below $8.00.

    Is it too early to start pricing in 2011? Not really.. The market tends to price things in early 6 months in advance and there is plenty of optimism to think (F) Ford could hit its profitability target earlier than Alan's 2011 call.

    But, if anyone is scared of how high some of these stocks have traded... Buy a PUT!

  • Report this Comment On August 13, 2009, at 4:56 PM, plange01 wrote:

    its time to sell ford.it has had a nice run but the depression in the US is getting worse and the cash for clunkers is already dying down....

  • Report this Comment On August 13, 2009, at 5:31 PM, plange01 wrote:

    when you see a stock like harley davidson more than double. with terrible sales you know your in a false rally of record size!wall street may be in dreamworld but not your average consumer who is a little to smart to buy motorcycles in a depression......

  • Report this Comment On August 13, 2009, at 9:16 PM, warrenrial wrote:

    Ford, How I see ford is very simple. It's a company in which the name says it all. FORD simply means

    Fixed Or Repaired Daily. So they should do well in the future market.

  • Report this Comment On August 14, 2009, at 7:57 PM, carlperkins1 wrote:

    Does anyone remember Webvan and the potential they had. The convenience of ordering from home and not having all the hassle. Why did it fail; outside of it spending way too much money on fancy furniture. It failed because of “People”. People wanted to go to the grocery store; smell the fruits and walk the aisles and hopefully ask the cute guy or girl for their number. People need brick and mortar building if they meet their criteria.

    I have two reasons why I think Borders stock price will rise. I don’t profess to be right, but these are just my observations.

    1. I have visited several stores in the morning, afternoon and right before closing. In several cities in Southern California. Each time the stores were full of people. The location in South Pasadena was especially packed. Mom and Dad looking at a magazine, while the kids would run up to them and then run back to the kids section. A little annoying hearing JR. yell “Mommy, Mommy get me this”, but they were buying things and making a family outing.

    2. When I visited the Pico Rivera location, I spoke to an employee. She said, business hasn’t gone down, but they have cut some of the supervisors. If you go on jobvent.com this can be validated. The April financial filing mentions downsizing. She noticed they stopped ordering a lot of everything; only what was needed. This also goes with what was officially noted by Borders. I believe, when Borders files with the SEC, we will see them turning a profit and lowering their debt.

    Because of these two things I am going to keep buying Borders stock. Now, the thing which is worrying me is all of the Management changes that are going on. This does scare me.

  • Report this Comment On November 12, 2009, at 8:08 AM, progmetal wrote:

    Just because you saw people in a store does not mean that they are buying anything, Customers just use Borders to browse and get their info for free. They lounge around and leave their stacks of books and magazines laying around for anyone to put away except themselves. Try making a profit off a $2 cup of coffee someone milks for hours while creating more work afterwards for the employees. They come w/ pen and paper and just copy the info. Everyone wants free info and entertainment these days. Borders shoppers are no different. They have been made in to coupon whores who now only buy something if there is a coupon or deep discount which equals zero profit for Borders. Borders could not even get the bank to take the company Paperchase off their hands for debt consolidation. Borders is doomed by 2011 especially w/ the price wars for books at Wamart and Amazon.com

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