Please Don't Buy This Stock

Here's a statistic that ought to make every long-term investor shudder, courtesy of JMP Securities analyst Michael Hecht: A mere five stocks were responsible for as much as 30% of the trading volume on the New York Stock Exchange in August.

It gets worse. Guess what those five stocks were?

Nope, guess again
Rather than transact in Wal-Mart (NYSE:WMT), Best Buy (NYSE:BBY), or any of the hundreds of NYSE-listed companies with straightforward business models and clean financials, these traders have been buying and selling cheap financials. Take a look at their "top five" list below:

Data from Capital IQ, a division of Standard & Poor's.

After reviewing that list, you should have two key takeaways:

Takeaway No. 1: Those companies stink!
I shouldn't have to tell you why buying any of those companies is a bad idea. But here are a few quick highlights – er, make that lowlights – in case you're tempted to trade any of those names, courtesy of Foolish financials expert Morgan Housel.

• Citigroup is undergoing significant structural changes, was forced to sell its profitable Smith Barney unit to Morgan Stanley out of desperation, and is about to dilute the heck out of current shareholders.
• After driving Bank of America to the edge of collapse, CEO Ken Lewis is stepping down at year's end with $68.8 million in deferred benefits and compensation. He may want to use that money to hire a good lawyer; word on the street says Lewis could face civil charges for "materially lying" to shareholders about $3.6 billion in bonuses paid to Merrill Lynch execs last year.
• Fannie Mae has openly admitted that it is no longer being "managed with a strategy to maximize shareholder returns." According to many industry experts, shares of Fannie and sibling Freddie Mac are worthless.
• And last, but certainly not least, we have AIG, the company that nearly destroyed our financial system as we know it. Even if this beaten-down insurer is able to sell off its assets for favorable prices and repay the government -- and that's a big if -- AIG still has to win back the insurance market's confidence to survive. That's why Morgan called the company "as speculative as it gets."   

Do any of those sound like businesses you'd like to own? Some of you must be nodding your heads, because …

Takeaway No. 2: Those companies' shares have skyrocketed!
Each of these fundamentally flawed financial companies' shares have surged over the past three months because … um … well, I actually have no idea why. These are objectively awful companies with convoluted business models, indecipherable financial statements, and shoddy management. And to top it off, they're pretty much impossible to value!

To put those three-month returns in perspective, consider that Best Buy and Wal-Mart -- two companies with strong competitive advantages, solid balance sheets, and histories of steady free cash flow generation -- saw their shares increase just 14% and 3%, respectively, over the same period. It seems that investors are eschewing high-quality companies in favor of low-priced, distressed stocks.

That hardly sounds like a successful investing strategy to me.

An actually successful investing strategy
Instead of buying shares of the flawed five above, why not focus on companies with straightforward business models, strong balance sheets, shareholder-friendly management teams, and bargain valuations? That's what Fool co-founders David and Tom Gardner do at Motley Fool Stock Advisor. One of David's top spots for new money that fits this bill is Activision Blizzard (NASDAQ:ATVI), the largest video game publisher in the world.

Thanks to last year's merger of Activision (which published popular console titles like Guitar Hero and Call of Duty) and Vivendi (whose Blizzard subsidiary created the subscription-based World of Warcraft series), Activision Blizzard owns a series of strong game franchises that keep the recurring revenue flowing. And that revenue should only increase in the years to come. According to PriceWaterhouseCoopers, global video game sales are slated to increase from $41.9 billion in 2007 to $68.4 billion in 2011.

But though Activision Blizzard has nearly $3 billion in cash sitting on its balance sheet and is on pace to generate $1 billion in free cash flow this year, the company's stock is still trading 20% below its 52-week high.

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Rich Greifner owns shares of Fannie Mae and Freddie Mac, but wishes he didn't. The Motley Fool owns shares of Best Buy. Best Buy and Activision Blizzard are Stock Advisor recommendations. Best Buy and Wal-Mart are Motley Fool Inside Value recommendations. The Motley Fool has a disclosure policy.