It's true that the market tsunami has left some dirt cheap value stocks in its wake, but if you don't have the cash to buy them, the opportunity will pass you by. Now is the time to go through your portfolio to see what you can sell to raise some cash.
Yes, many of your stocks are already trading for a loss, and yes, "buy high and sell low" is the exact opposite of how you're supposed to invest. But in today's market, selling weaker companies for a loss and reallocating the money to better investments is a sound strategy, for it will be the best-run companies that survive this storm and thrive when the market turns for the better.
At a time when you can find so many cheap stocks, it makes no sense to hold onto companies facing enormous headwinds just because they are discounted. So here are two investments to consider selling in this market and one idea for where to put your money.
Second-rate consumer services companies
With unemployment on the rise, credit-card companies slashing credit limits and raising rates, and one in six homeowners underwater on their mortgage, the U.S. consumer is in a bad place right now with no sign of recovery in the short run.
This isn't just a cyclical spending slowdown that will take months to work itself out, either. The $6.2 trillion in debt that U.S. households took out between 2000 and 2007 fueled much of the consumer-related growth we've experienced in the past decade -- on SUVs, flat-panel TVs, and granite countertops and other luxury goods. This massive debt burden will need to be paid down before a healthy recovery can occur.
To achieve this, households will be saving more and spending less. More importantly, when they do spend they will not only be more price-conscious but more selective about where they choose to do their spending. Put simply, the stronger companies will survive, while the weaker ones will fall further. If you own the latter, they should be the first to sell from your portfolio.
While CVS Caremark (NYSE: CVS ) , for example, is naturally suffering in this climate, its financial health has long been much better than that of its second-rate competitor, Rite Aid, which is mired in debt, is closing stores, and posting massive losses. The market will naturally punish inefficiently run businesses, and in this market, you don't want to be betting on the weak horse.
So, ask yourself, "Are the consumer stocks I own the best-in-class?" If you're not sure, look at their margins and sales growth versus competitors and the industry at large. Along these lines, I'd much rather back top-notch names such as Nike (NYSE: NKE ) and Coach (NYSE: COH ) with their 13% and 35% operating margins, respectively, than K-Swiss' 1% margin.
Companies with high debt and no free cash flow
Similarly, you want to get rid of companies with excess debt on their balance sheets and negative free cash flow. When sales and earnings are down, fixed costs like interest expenses and rent payments become even more pronounced. Without free cash flow generation, the company must burn through the cash on its balance sheet, sell assets, issue stock, or borrow even more money just to make do. This is not a winning formula.
Just look at what's become of Raser Technologies (NYSE: RZ ) this year -- it's more than 75% off its 52-week high. The geothermal power developer hadn't generated any free cash flow in years and is today armed to the teeth with long-term debt -- to the tune of $80 million against just $284,000 in revenue. One of the company's solutions, announced in November, was to issue a private placement (not available to general public) of common shares to raise $20 million -- diluting existing shareholder value in the process. To a lesser extent, a similar story has played out at Palm (Nasdaq: PALM ) over the past year, and the distressed company was handed a lifeline earlier this week in the form of a $100 million equity investment from Elevation Partners.
Bottom line: There's no reason to hold onto an over-leveraged company with no means of paying its debt other than at the expense of shareholders. If you own a company like this, consider selling it to free up cash.
What to buy
Even though selling for a loss may wound your pride -- no one likes to admit defeat -- you're better off sacrificing the battle to focus on winning the war. That means reallocating capital from poorly run companies facing extreme headwinds and putting it behind well-run companies with the wind at their back.
One industry you should consider putting money behind is health care, which will benefit from the aging of baby boomers in coming decades. And talk about timing -- this market has provided us with an opportunity to buy great health-care companies at great prices just as baby boomers enter retirement age. Sure, you can stock up on behemoths with hefty dividend yields such as Eli Lilly (NYSE: LLY ) and Bristol-Myers Squibb (NYSE: BMY ) , but there are also plenty of higher growth health-care companies trading at substantial discounts.
In a recent issue of Motley Fool Inside Value, the team named Quest Diagnostics a "great buy" now because:
It already benefits from the increased number of medical tests taken as we age, and that will only improve with the use of preventative measures to reduce health-care costs. Quest is a leader in innovative new tests, which carry higher profit margins. The company has paid down $435 million in debt so far this year, and it should pay down more over the next two years.
If you'd like to hear more about what the team thinks of Quest Diagnostics and other great places for newly freed-up cash, consider a free 30-day trial to Motley Fool Inside Value. To get started, please click here.
This article was originally published Nov. 21, 2008. It has been updated.
Todd Wenning congratulates his beloved Cincinnati Bengals on their recent win against that other Ohio team, the Browns. He does not own shares of any company mentioned. Eli Lilly is a Motley Fool Income Investor selection. Coach is a Motley Fool Stock Advisor recommendation. Quest Diagnostics is an Inside Value pick. The Fool's disclosure policy is more than a feeling.