Doomed Stocks You Should Avoid

The amazing thing about this market is that there are so many cheap stocks. The problem with this market is that there are so many companies that could really blow up on investors.

Your investing success in the next year will be largely determined by your ability to sniff out and avoid losers. With that in mind, here are some suggestions for stocks you should avoid.

Speculative companies
Right now, you should avoid money-losing businesses, companies that need high growth to justify their high earnings multiples, start-up companies that are dependent on the growth of new markets, and other speculative stocks.

Right now, you can find solid, blue-chip stocks that are undervalued by unprecedented amounts. If you can buy a stock that should be trading at double or triple the price, why would you want to risk your money on a stock with less probable gains? In such an environment, speculative bets just don't make sense.

For instance, right now Ford Motor (NYSE: F  ) is trading at lows that come about once every decade -- and yet it's still not a great idea to invest. The company is in a horrible economic situation, it's getting pummeled by superior foreign builders, it supports tons of debt, and it hasn't exactly proved to be a smart capital allocator over the course of time.

Why would you even consider buying Ford when you can get a company like Novartis (NYSE: NVS  ) -- a high-quality operation with a very strong balance sheet – at just 15 times earnings? Ford simply doesn't make sense.

When even established, well-capitalized companies are seeing strong headwinds, stay away from the companies that aren't well-positioned.

Cash-poor businesses
Sometimes businesses report earnings but don't produce cash. Sometimes earnings are recognized as an accounting gain immediately, but the cash comes in later. Sometimes capital expenditures can exceed operating cash flows. None of these should give you confidence in a market like this one.

In good times, cash-poor businesses can borrow money or sell equity to tide them over until the business starts producing cash. But in more challenging times, they may only be able to borrow at high rates, sacrificing the long-term cash flows of the company to service the debt. Worse, they may not be able to borrow at all -- and thus be forced into bankruptcy.

It may not even be the result of poor management ; some industries are chronically cash-poor because of their capital-intensive nature. Consider resort businesses like Wynn Resorts (Nasdaq: WYNN  ) and Las Vegas Sands (NYSE: LVS  ) , for example, that are constantly burning tremendous amounts of cash to build the next big thing.

Palm (Nasdaq: PALM  ) , yet another example, has been in the news recently, especially with its new device, the Pre, generating a lot of buzz. But its operations are burning more cash than they are bringing in. Developing a new, hit phone costs money (especially one that is going to battle the iPhone) and that's fine. But the lack of free cash flow is nevertheless worrisome in an environment in which cash may not be forthcoming to make up for significant shortfalls. Beware dilution.

Near-term debt maturities
The credit crisis we're in means lenders are risk-averse and attempting to reduce their leverage. That means that even profitable companies can run into trouble if they have debt maturing that they can't pay off from cash or rollover.

Exelon, for instance, has considerable hurdles in the near term, with aging infrastructure, large amounts of regular capital expenditures, and very significant cash obligations related to near-term debt obligations. This is a situation that should merit a second look.

I would be similarly concerned if I held a company like Sprint Nextel (NYSE: S  ) . Though the company is making cash, it carries a whole lotta debt, some of which comes due fairly soon. This is a troublesome situation.

Given the tightening of corporate credit across the board, stay away from companies with significant debt coming due anytime soon.

Broken business models
Because credit is the grease of the business world, the credit crisis means the rules of the game have changed. Business strategies that worked two years ago, like depending on borrowed money, are now much less feasible.

Consider securitization, the practice of pooling loans into bond-like securities and selling them to investors. The housing bust has caused the value of mortgage-backed securities to plunge, and other securities have done the same. Consequently, investors are reluctant to buy, and while these securities are unlikely to go away, they may become more regulated. They'll certainly be much harder to sell, and therefore less profitable, in the future.

It's apparent that this change will directly affect most lenders, from Bank of America (NYSE: BAC  ) to Wells Fargo. But it will also indirectly affect any company that expects its customers to buy on credit. This ranges from car manufacturers like Toyota Motor to big-box electronics-items makers like Sony. If that new car loan is harder to securitize, consumers will be charged higher interest rates, and that will in turn reduce the demand in general -- and thus for all of the parts, supplies, and labor that go into those vehicles.

So you should be cautious of companies that have business models that don't work in an environment where it's hard to borrow money at reasonable rates, businesses are deleveraging and downsizing, and consumers are scaling back.

The Foolish bottom line
All that being said, don't just blindly avoid any stock that has one of these flaws. Do, however, investigate further. Sometimes the issue will be catastrophic for shareholders, but sometimes it will simply be a small hurdle affecting a fraction of the overall business.

These are just some of the issues we examine at Motley Fool Inside Value while deciding whether a stock is truly cheap or just a value trap. To see our favorite stocks in this market, take a 30-day guest pass to Inside Value. Click here to get started -- there's no obligation to subscribe.

Already subscribe to Inside Value? Log in at the top of this page.

This article was originally published Dec. 5, 2008. It has been updated.

Fool contributor Richard Gibbons has no positions in any of the securities mentioned. Novartis is a Motley Fool Global Gains pick. Sprint Nextel is an Inside Value choice. The Fool's disclosure policy is anything but doomed.

Read/Post Comments (10) | Recommend This Article (13)

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 October 02, 2009, at 5:09 PM, mipakaco wrote:

    So this now makes FIVE Fool articles in one day trashing LVS. How original. Oh yeah, that trash LVS that you've bashed since the March lows of $1.38? It's now in the $16's. So anyone who actually followed your idiotic advice and stayed away, has missed a 1200% gain in only 6 months. I'm sure your expert stock pickers are up that much in 6 months. I didn't thin so. One last thing. In your 5 trash articles did you mention even once that LVS is having another casino coming on line in SINGAPORE? Marina Bay Sands, and they are one of only two licences there? You know, the casino that analysts are already saying will be the most profitable in the world? No, you conveniently always leave the facts out, and continue to spew the crap. Fools indeed.

  • Report this Comment On October 02, 2009, at 5:13 PM, QwertyHero wrote:


  • Report this Comment On October 02, 2009, at 6:24 PM, xebec5 wrote:

    New device, the Pre.....don't you mean the Pixi? That is Palm's newest device soon to be released.

    But the lack of free cash flow is nevertheless worrisome -- Really? Sept 28 public offering of 23 million shares and received net proceeds of about $359.9 million didn't seem to be a problem for Palm.

    I have a dog in this hunt, but do you?

  • Report this Comment On October 02, 2009, at 7:12 PM, series101 wrote:

    I had to double-check the date of this article in reference to the claims about Ford. While the statements regarding foreign competition were true a few years ago - the current situation is different. I would suggest the author read up on current events - check JD Power for reliability ratings, look at recent sales trends, look at auto test reviews such as Camry vs. Fusion (especially hybrid versions) or F-150 vs. Tundra - "Pummeled" really doesn't apply here.

    While Ford isn't in an ideal financial situation by any stretch, they are ahead of schedule for returning to profitability. One last thing, Ford is bringing some very good product from their European operations into the US in the next couple of years and that should make them even more competitive.

    This inaccurate view of Ford brings into question the merits of the entire article.

  • Report this Comment On October 02, 2009, at 9:04 PM, Varchild2008 wrote:

    FORD does suck... I think everyone should DUMP THEIR SHARES OF FORD NOW!!!!

    Abandon ship!!!! FORD IS TOAST!!!! Crrraasssssshhhhhhh!!!! RED ALERT RED ALERT FORD STINKS FORD STINKS... that everyone has panicked out of the stock...I'll go and buy more shares.... ;-)

    Get my point? I couldn't care less what anyone thinks of FORD as an investment. Seriously.. I don't care..

    FORD makes sense for my investment strategy/personality and retirement goals.... Therefore it stays in my portfolio.

    The day I think Novartis should be added to my portfolio....I'll add it.... But at $49+ a share? That's a bit pricy for me... Buying into CYOU only got me 30 shares for 1K of cash. And that one is much cheaper.

  • Report this Comment On October 03, 2009, at 12:54 AM, NASDAQCZAR wrote:

    i disagree on S Sprint, mainly because of Boost Mobile $50 unlimited plans and Virgin Mobile has matched the $50 unlimited plans taking subscribers away from Verizon Wireless, both use Sprint/Nextel Network im sorry but if anything S Sprint should head to double digits, for record i have no S position nothing at stake with S,

    but i do use virgin mobile and they're an up and coming cell phone service and Boost is popular with young people as well the youth seem to like VM, It is extreme articles like the headline of DOOMED STOCKS that is a turnoff and tarnishes the credibility of this site with extreme views,as well Richard Gibbons should sell short S if he believes what he writes and post verification he is shorting S with the # of shares.

    put the facts up not bs, as well trashing Sprint doesn't help the economy rebound, as the economy rebounds Sprint will benefit so i am more bullish on S and i dont even have 1 share or 1 bond of the debt, As far as Ford goes theyve been in business for nearly 100 years and have done pretty well without govt help i dont see Ford imploding anytime soon either but i wont buy F stock either eom

  • Report this Comment On October 03, 2009, at 1:14 AM, Fool wrote:

    I love how these days that anyone can write an article with so little knowledge of the various industries. I study the auto industry and Ford builds a competive product. Look at the sales figures. Have you driven a Ford Lately?

  • Report this Comment On October 03, 2009, at 10:16 AM, biotechnique wrote:

    The Motley Fool group is becoming is becoming more irrelavent with every BLOG they write....i can get more reliable info from a YAHOO message board. Why are they being allowed to broadcast this crap?

  • Report this Comment On October 03, 2009, at 6:29 PM, Fool wrote:

    "So you should be cautious of companies that have business models that don't work in an environment where it's hard to borrow money at reasonable rates..."

    Seems to be a pretty broad brush to me Richard

  • Report this Comment On October 04, 2009, at 11:09 AM, spokanimal wrote:

    Although the lead response re: LAS VEGAS SANDS by mipakaco is very accurate, I have a different take on your the disdain Motley Fools foists on LVS.

    Good companies only accelerate their stock market gains when there is a sufficient "wall of worry" that surrounds the comany. For example, LVS's B- credit rating is a wonderful thing now that debt covenenats are loostened, Macau revenues are surging, and an IPO will likely raise capital. Meanwhile, the "lagging indicator" credit rating keeps risk-averse people out of the stock while people who really understand what's going on provide the demand for LVS that's needed.

    The risk-averse crowd are the people we need to enter this stock as it transcends from it's growth stage to it's maturity stage. To top a stock out, you need these "Johnny-come-latelies" to provide the power to propel a company like LVS to it's ultimate sell point... when euphoria sets in.

    Similarly, Motley Fool, and other similar media outlets, must continue to spread "skepticism" about LVS so that the wall of worry remains high and only knowledgable people (Like Adelson's purchases last March) are the ones moving the company during the first year... which in any bull market is typically the most profitable year.

    Once the credit rating hits BB or BB+ and analysts start piling on with buy ratings, that should be the point where Motely Fool starts writing positive articles about LVS.

    That's the point where contrarians like me will sell LVS.


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