On Monday, WCI Communities succumbed to the inevitable and filed for bankruptcy. In a previous article, I used Motley Fool CAPS, our online investing community, to highlight seven builder stocks ready to wreck your portfolio, including WCI. Sure, maybe that was a lucky fluke. Then again...

"Luck is what happens when preparation meets opportunity," as the Roman philosopher Seneca said. A bit of research before you invest can give you a critical competitive advantage, and vastly improve your chances for success.

CAPS can help, especially when it comes to finding some of the market's worst businesses, such as Freddie Mac (NYSE:FRE). Stocks like these will almost certainly become potholes, if not outright roadblocks, on your path to riches. Spotting them in advance with the aid of CAPS gives you plenty of time to steer clear.

To find these dubious stocks, we'll screen for a few simple criteria:

  • We'll start by seeking stocks with CAPS' lowest one-star ranking, and which bear at least 200 All-Star underperform picks. All-Stars are our highest-scoring members, having earned their ratings through Foolish picks that outperform the market.
  • Insiders on sinking ships couldn't care less about shareholders. One way to check this is to look for companies with very low levels of insider ownership -- in this case, below 4%.
  • Balance sheets of hurting enterprises often are overleveraged. Check for businesses with more debt than equity, represented by any debt-to-equity ratio higher than 1.
  • Finally, a return on equity of less than 5% indicates of a tough and potentially failing business. As the screen will show, many of these companies won't be profitable at all.

Individually, those criteria don't define a company in trouble; for instance, low total insider ownership can happen even when the insiders hold large amounts of personal wealth with the company. But together, they have the chance of finding stocks you might want to avoid right now. Here's what the screen came up with today. Most of the names probably won't surprise you.

Company

All-Star Underperforms

Insider Ownership

Long-Term Debt to Equity

Return on Equity (TTM)

Lehman Brothers (NYSE:LEH)

280

3.6%

6.65

Not Profitable

Ambac Financial (NYSE:ABK)

229

0.3%

7.57

Not Profitable

Ford (NYSE:F)

651

0.5%

23.79

Not Profitable

Merrill Lynch (NYSE:MER)

244

0.5%

10.36

Not Profitable

Blockbuster (NYSE:BBI)

288

1.9%

1.22

3.2%

Source: Motley Fool Caps as of 8/06/08. TTM = trailing 12 months.

Please note that these companies could be deep values -- or value traps. As always, before you go long or short, it's important to do your own due diligence. That said, here's what a few CAPS community members have to say about these businesses.

Earlier in the year, TMFWBuffetJr wrote this about Lehman Brothers:

Warren Buffett warned that the problem with such a fantastic party like we had at Cinderella's mortgage ball over the last five years is that there are no clocks on the wall. He said the drinks taste a little better, the girls get a little prettier, and so you stay for just one more dance. But eventually midnight hits and everything turns back to pumpkins and mice. Lehman is caught holding a lot of pumpkins and mice, they're just trying to hide it a little while longer than everyone else.

Tastylunch made a good point about Blockbuster back in April:

The ONLY problem is that you don't have nearly enough money/equity to buy [Circuit City (NYSE:CC)]. Oh forgot that did we? No problem just go get crazy financing, oh wait. Now that banks, private equity firms actually have to be somewhat responsible there's virtually no way anybody will help you fund this quixotic venture!  

In March, Member mkdcardinal asked a very good question: "Why is it OK for 'big government' to intervene when big investment banks are in trouble, but laissez faire 'free trade' orthodoxy reigns supreme when it comes to saving the jobs and life savings of normal Americans?"

Regardless of where you sit on the fence of luck, there's no denying that CAPS helped me locate (and avoid) a seriously distressed asset like WCI Communities. It could do the same for you. Go ahead and sign up, absolutely free. Our CAPS community of more than 110,000 members -- made up of some of the brightest minds around -- would like to know what you think.

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