Doomed Stocks You Should Avoid

The amazing thing about this market is that despite this recent market tear, there are still so many cheap stocks. The problem with this market is that there are so many companies that could still really blow up in investors' faces.

Your investing success in the years to come 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, stocks like Citigroup (NYSE: C  ) and Bank of America are still trading far, far lower than they ever were three years ago -- but they're still not cheap. God knows what these companies are still holding in their books; it's really anyone's guess what these companies are worth. Why would you even consider these nebulous banks when you can get Costco (Nasdaq: COST  ) -- arguably one of the strongest companies in the world -- trading for just 18 times forward earnings?

When even established, well-capitalized companies are facing strong headwinds, stay away from businesses 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 the 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. Semiconductor companies, for example, often have to spend their profits on the next generation of equipment just to compete.

LDK Solar (NYSE: LDK  ) , for instance, has been profitable and was previously growing quickly. But it's burning cash with its huge capital expenditures. Of course LDK needs to make capital expenditures to grow, and thus far, it's been successful selling shares to raise cash. But the lack of free cash flow is nevertheless worrisome in an environment in which cash is not flowing freely to make up shortfalls.

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 roll over.

Retailer Talbots, for instance, is facing a sticky situation, with a cash-burning business and a significant amount of debt coming due in the next two years. In an environment where even more trendy brands like Gap (NYSE: GPS  ) and Abercrombie & Fitch (NYSE: ANF  ) are getting spanked, what happens to a company that can't make money or pay back its debt?

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 affect most lenders, from Capital One Financial (NYSE: COF  ) to General Electric. But it will also affect manufacturing companies like Ford (NYSE: F  ) . If car loans are harder to securitize, consumers will be charged higher interest rates, and that will in turn reduce the demand for Ford's vehicles -- 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.

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

Fool contributor Richard Gibbons also avoids narwhals, nail guns, and knaves. Costco is a Motley Fool Inside Value pick, Stock Advisor selection, and Fool holding. The Motley Fool has written bear put spreads on Abercrombie & Fitch. The Fool's disclosure policy is anything but doomed.


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

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 December 11, 2009, at 7:23 AM, Ishortyou wrote:

    seems to make sense, the rules of the game have changed, the credit bust seems to be similar to the tech bust and may remain low for a long long time, that means that the system will now have to have cash in order to trade, and to have cash you have to work for it and save..

  • Report this Comment On December 11, 2009, at 8:15 AM, Fool wrote:

    This article was originally published Dec. 5, 2008. It has been updated???? What does this really mean? Does this mean this information is a year old? It says it has been "updated"??? What has been updated, and what has not? COST for example, was mentioned, is this current or from a year ago?

  • Report this Comment On December 11, 2009, at 8:47 AM, gageaa wrote:

    Yet Ford was one of Stock Advisor's last picks, due to its profitability and management. Who should I trust? The naysayer or the yea-sayer?

  • Report this Comment On December 11, 2009, at 8:54 AM, pondee619 wrote:

    Fool:

    The "article" was originally published on Dec. 5, 2008 AND reprinted each and every month thereafter. There is no original content on these fool pages unless you pay for it. "These are just some of the issues we examine at Motley Fool Inside Value". These "articles" are nothing but fluff pieces to get us to buy a service touting two stocks a month for us to buy.

    You see, in these "articles" all the time: "these are not formal recommendations"; "All that being said, don't just blindly avoid any stock that has one of these flaws" in an "article" saying to avoid these "doomed" stocks; "this is just to provide you with ideas to start your own research": etc..

    You will get nothing of any import on these pages. Don't rely on anything you read here. You will just get an ad (repeated ad nauseam) for a service. If you bought all of the services offered you'er out $1,493 a year. And then you get to read an "article" about how you should cut down on starbucks to save for your retirement. ( Only want one service to cut down expenses? Which one to gamble on? They are all great.)

    You will be told that these free pages are only to whet your appetite for their paid services. Well, my position is, If the free appetizer is turds in a blanket (reheated and re-served at that) , I'm not springing for the entree.

    You asked: "This article was originally published Dec. 5, 2008. It has been updated???? What does this really mean?" It means that the witer has just been too lazy to provide his/her readers with fresh original material. But watch, it will get its recs. If the public wants crap, give them crap. The fools new motto.

  • Report this Comment On December 11, 2009, at 10:18 AM, f81z7g391 wrote:

    And not to forget that this site ran over 120 articles tha warned you from buying Ford last year, as the stock went from $1.60 to over $9 a share, great advice!

  • Report this Comment On December 11, 2009, at 10:50 AM, FoolsSpecialK22 wrote:

    Ya'll recommended LDK a while back, and I bought. I enjoyed reading pondee619's comments and it opened my eyes a bit more. Something's just not right here.

  • Report this Comment On December 11, 2009, at 1:15 PM, pondee619 wrote:

    I wouldn't love it if there were no Motely Fool, I just would like (expect) them to live up to their potential. If we are to believe that the writers are trained investment analysts/professionals, let's write like it. Let's not continue to rehash old stories. (cutting and pasting some stat off the net) Let's have stories that provide indepth commentary, some information that is acuially useful. Let's have stories that provide added value, not just listing some stocks by their "star rating' and tell us they are "poised" to do something. A reason why, other than it's star rating, would be nice. A story that any fool would be proud of that actually said something constructive.I know,. I'm asking too much.

    Let's stop accepting the stories as currently provided and demand somthing more. Is the Fool up to it?

    As an example, what did the above "article" say?

    "Doomed Stocks You Should Avoid" it then goes on to tell us of some. Then: "All that being said, don't just blindly avoid any stock that has one of these flaws" Doomed stocks you should avoid but not necessarily avoid. Poetic license is fine for the gossip pages, but some folks take investment advise seriously.

    "The Best Energy Stock, Period By Toby Shute

    December 9, 2009" "While Core Labs isn't obviously undervalued today, this may be the best energy company I know of, period" Now, saying that a stock is the best anything, period, you state that absolutely. Nothing MAY be absolutely anything. If a stock MAY be something it also MAY NOT be the same thing. "When it comes to oilfield services, you know I love my offshore drillers. Tops would be Noble (NYSE: NE), with Ensco International running a close second" "Another standout in the services realm is Core Laboratories" According to Toby, Core Labs MAY be the best energy stock, period. (of course, it may not be also, let's keep our options open, Toby) But it is not first or second in its sector (oilfield services) it is just another stock in that sector, an also ran. This is passed off as clear decisive writing.

    "Cancel Christmas! By Dayana Yochim

    December 9, 2009" "the average credit card debt increased 4% from October and has risen 14% since June."

    "The Daily Walk of Fame: Consumers By Tim Beyers

    December 9, 2009" "October marks the 13th consecutive month in which credit card balances have fallen," Same day, credit card balances are reported to have fallen and risen at the same time. Then: "Report this Comment On December 09, 2009, at 3:51 PM, TMFMileHigh wrote: Either way, the trend is what matters here...Tim (TMFMileHigh and @milehighfool on Twitter)" Which trend is to be followed the falling one or the rising one?

    I started reading the fool because I thought they could supply some insight. The more I read, the less insightful they became.

    take a 30-day guest pass to Inside Value. Click here to get started

  • Report this Comment On December 11, 2009, at 4:27 PM, tashchuk wrote:

    Well said, pondee619.

    But it gets even worse. Recently Fool has posted articles that aren't simply "updated", they're completely computer generated without any human involvement at all. I forget exactly how they phrase this.

    Nowadays Fool exists mostly to get people to pay big bucks for the premium services. Sad.

  • Report this Comment On December 11, 2009, at 4:28 PM, tashchuk wrote:

    Well said, pondee619.

    But it gets even worse. Recently Fool has posted articles that aren't simply "updated", they're completely computer generated without any human involvement at all. I forget exactly how they phrase this.

    Nowadays Fool exists mostly to get people to pay big bucks for the premium services. Sad.

  • Report this Comment On December 11, 2009, at 4:29 PM, tashchuk wrote:

    Sorry about the double post. I try to keep JavaScript disabled most of the time. That keeps the pages from refreshing properly when I post.

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