These Stocks Are Trash!

A few years ago I was sledding with my wife in her hometown of Virginia Beach when I heard someone yell "Whooooooo, Mt. Trashmore!" as he soared down the snowy hill. Thoroughly confused, I turned to my wife and asked, "Mt. Trashmore -- what the heck is that?"

A dirty trick
I soon found out that Mt. Trashmore is a landfill being put to new uses; in winter, covered in snow, it just looked like a great place to go sledding! In the spring, it becomes a park crowded with residents using basketball and volleyball courts, enjoying the rolling green hills, and climbing the hiking trails that surround a beautiful lake.

But underneath it all -- it's just three miles of trash!

Why should you care?
If you think about that situation, it seems eerily similar to the stock market.

Consider this: How many times do you see a share price shoot up and think to yourself, "Wow, that must be a great company"? Then, after doing some research, you find out the business is drowning in debt and hasn't made money in years.

Look at AIG (NYSE:AIG) or Fannie Mae (NYSE:FNM). Both companies have experienced price increases of at least 100% over the past six months. Those are incredible returns! But what's more incredible is that both were recipients of more than $30 billion in taxpayer bailout money, both suffer from sloppy management, and both are expected to post huge losses for 2009.

Rising prices can make companies look good on the surface -- just like Mt. Trashmore looked good to me -- but when you take a closer look, they're simply trash!

Take a look at some of this junk:

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

These stocks have seen astronomical gains in the past six months, but they're trading at ridiculously high valuations, they're riddled with debt, and their businesses are struggling during the recession. But after huge run-ups, they're valued as if they are about to enjoy tremendous earnings growth for several years.

Some of these companies may have been smart picks once upon a time, but if you have them in your portfolio right now, I'd take your gains and toss the stocks in the incinerator as fast as you can.

Don't be fooled
In actuality, Mt. Trashmore isn't such a bad thing. It employs the best possible use of urban land by combining recreation with waste management.

But stocks like the ones above don't serve a purpose anymore. They are deceptive because of their extraordinary returns and often push you along with a herd of other investors who are only concerned about short-term price movements. That hardly sounds like a practical investing strategy.

Instead of following the pack or keeping stocks in your portfolio that clearly don't belong, why not try a simpler, more levelheaded approach? Look for companies that have clean balance sheets and limited debt, that have strong positions in their competitive landscape, and that are trading at favorable valuations. That's what co-founders David and Tom Gardner do at Motley Fool Stock Advisor. They recommend companies like Adobe Systems (NASDAQ:ADBE), Activision Blizzard (NASDAQ:ATVI), and Netflix (NASDAQ:NFLX).

Each of these companies has negligible debt; all three have increased earnings significantly over the past three years. Adobe Systems is a leading software provider for graphic design (which includes the Web's omnipresent PDF files), and Activision Blizzard is one of the world's largest video game publishers. Netflix single-handedly destabilized Blockbuster's business model and continues to innovate by delivering DVDs to your house and by streaming video directly to your TV.

Want to learn more about these companies, or any of the stocks that David or Tom are suggesting to buy right now? If so, you can click here for a 30-day free trial. There's no obligation to subscribe.

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Fool editor Jordan DiPietro doesn't own shares of any of the companies mentioned above. Adobe Systems, Activision Blizzard, and Netflix are Motley Fool Stock Advisor recommendations. The Motley Fool has a competitive but prudent disclosure policy.