5 Deathbed Stocks

We've all heard of the "death rattle," the last gasp from a lost soul's lungs. Sometimes, we seem to hear it from the companies in which we invest.  Revenue dries up. Margins contract. Profits evaporate. All these signs suggest that a company's condition is worsening -- a financial death rattle, if you will.

Stocks in sickbay
Don't assume that all such companies are goners. Some will barely cling to life, while others make a full recovery. Nonetheless, here we're seeking companies that have all but given up the ghost.

For help, we'll turn to the clever coroners at our 105,000-strong Motley Fool CAPS community, where players give the thumbs-up or thumbs-down to more than 5,600 stocks. The first year of collecting data suggests that CAPS' highest-rated stocks performed best, while its lowest-rated companies fared worst. We've unearthed a handful of stocks that look like they might be headed six feet under, having recently dropped from two stars to the lowest one-star rating.

First we'll check out some quick tests for liquidity -- the current ratio and quick ratio (also called the "acid-test" ratio) -- which gives us an idea of a company's ability to pay its bills. A current ratio above 1.5 and a quick ratio north of 1.0 means a company is able to meet its short-term operating needs. But watch out! Too high a value might mean that it's hoarding assets that could be better used elsewhere.

We've also added the Altman Z-Score. In the 1960s, Edward Altman used statistical techniques to predict the likelihood of bankruptcy, based solely on five financial ratios. The New York State Society of CPAs has said the Z-Scores are the "tried-and-tested formula for bankruptcy prediction," but please note -- they're not designed to be used in every situation, and they do have some limitations.

A company scoring 3.00 and above is considered safe; scores between 2.70 and 2.99 are in the "yellow flag" zone; scores between 1.80 and 2.70 mean the company has a good chance of going bankrupt within two years; and scores below 1.80 mean "Watch out below!"

Here's today's list. The question is, are these companies only mostly dead, or have they already given up the ghost?

Sources: Motley Fool CAPS; Capital IQ, a division of Standard & Poor's.

Looking at the names on the list, you might be tempted to think that some of these might need the ICU unit at most, rather than a cemetery plot. General Motors, however precarious its position, is still the top automaker, and it's implementing a plan to shore up its financial situation.

Moreover, not every type of company can be diagnosed by these quick tests: Financial institutions, for instance, typically don't get measured by such ratios. Even so, stocks that CAPS investors have marked down to one star are possibly destined to seriously underperform the market in the future.

Parade or funeral dirge?
The twin swords of rising corn prices and a glut of ethanol producers has cut Pacific Ethanol deeply in recent weeks. It needed to dip into a new round of financing, raising $34 million via a convertible preferred share offering, to keep itself going. Ethanol prices are up more than 50% over the past year, but corn has risen by 78%, and producers keep coming on the market.

Investors have had their fill of ethanol, and like most Congressional mandates, the idea of corn-to-ethanol suffers as a result of the Law of Unintended Consequences. Using food stock to make fuel drives up the costs of basic goods across many industries (including, oddly enough, energy, which is a major input into fertilizer production -- the law of supply and demand works here, too). As Stevegoldenfool notes, it won't assist our goal of finding appropriate alternative fuels:

We need our corn crop back for food consumption! Ethanol is definitely not the answer to our alternative energy needs. The answer lies in wind and solar but alas that does not apply to this ugly stock!

Rattling the cage
Are these companies doomed to drag their investors into an underworld of underperformance? Or will they recover to shine again? On Motley Fool CAPS, you have the power to tell your fellow investors just how you feel. Sign up today, absolutely free, and let us know whether you think the Grim Reaper's at the door.