Don't Poison Your Portfolio

Most of us wouldn't knowingly ingest poison and expect a positive outcome. I mean, come on -- it's poison. That stuff'll kill you, right?

So I have to wonder why so many investors gravitate toward poisonous stocks. Cheap or not, those stocks will kill your portfolio -- and when there are plenty of good stocks to choose from, it makes even less sense.

Of course, these stocks don't come with "Mr. Yuck" stickers or more to-the-point skull and crossbones symbols to warn investors of their toxicity. But there are two warning signs that, especially in the current environment, you'd do well to heed.

Toxic business
If a company's business is in the toilet and seeing no immediate signs of recovery, that's a sign to stay away -- even if it's cheap, and even if it is likely to recover one day.

Take UAL Corp. (NYSE:UAUA), for example. Although its stock got beaten down by 66.7% over the last year, over the last three months it has rallied by 43.2% as investors celebrated oil's drop from the scary highs that would have further constrained United's business.

So far, though, there's absolutely no reason to believe the airline company has fixed its actual business. Continued customer-abusive "strategies" like onerous fees for checking bags seem to be the best the airline companies can do. Meanwhile, United has a total debt-to-capital ratio of 118.9%, and in the last 12 months, it's lost a gut-wrenching $33.21 per share.

Or what about Ford (NYSE:F)? Its stock has plunged 76% in the last year, and at $2, it's still not cheap. It's no secret that the Big 3 have been making some seriously bad business decisions, and, as a consequence, Ford has been blowing through its available cash and has a debt-to-capital ratio of 100.

Both airlines and automobiles tend to be cyclical industries, so there's a chance they'll come back at some point. But as noted value investor Seth Klarman recently said, at some point being too early becomes indistinguishable from being wrong -- and I don't see any reason for investors to even try to take that gamble.

Toxic debt
One of the most poisonous attributes I can think of is a high level of debt -- especially given the current credit crisis. Match that with flagging profitability (or even net losses) and declining or anemic business and you may have a toxic combination on your hands.

For example, let's take a look at a few companies with high debt-to-capital ratios.

*All data from Capital IQ and Yahoo! Finance, 11/06/08.

These all look like hemlock to me, although some might be slightly more diluted doses than others. Cedar Fair is the only one that's managed to eke out a small profit in the last 12 months, and Trump Entertainment's loss over the last 12 months is pretty astonishing.

Exelixis is a biotech company, and granted, that industry is known for a higher degree of risk and, often, far superior rewards -- despite debt to help finance research and a near-term lack of profitability. Exelixis also has the highest stockpile of cash on the list. Still, especially in this environment, it's not a gamble I'd personally want to take.

After all, financing is harder to come by these days and interest rates choke the monies that companies bring in no matter what the macroeconomic climate. With consumers feeling strapped, many companies will also see less money coming in going forward -- and that's a recipe with a bad aftertaste.

Stocks for a healthy portfolio
There's absolutely no reason to take undue risks on such possibly toxic stocks -- especially when opportunities abound to buy strong, superior companies for the long haul. This bear market has reduced the price of any number of profitable companies with great brands and little or no debt on their balance sheets. Those are the kinds of stocks that will keep your portfolio healthy over the long term.

Tom and David Gardner have long focused on finding wholesome stock ideas for Motley Fool Stock Advisor. Recommendations Apple (NASDAQ:AAPL) and Nintendo are great examples of companies that are flush with cash, generate free cash flow, and have no debt -- and their recommendations overall are beating the S&P 500 on average by 28 percentage points. Why play around with poison when you can get a 30-day free trial to all of the Gardners' best bets for new money now? Just click here to get started -- there's no obligation to subscribe.

Alyce Lomax does not own shares of any of the companies mentioned. Apple and Nintendo are Motley Fool Stock Advisor picks. Exelixis is a Motley Fool Rule Breakers selection. The Fool owns shares of Exelixis. The Fool has a disclosure policy.