I'm a believer in Peter Lynch's "invest in what you know" philosophy.

Some of the better-performing stocks in my portfolio over the years have been in consumer-facing companies where I was an early adopter.

Well, this week I'm going to trash one of those stocks.

I'm no villain. I just go through this rite every week. I hate on a stock that I feel is headed for a fall, but I also come right back and offer three worthy replacements.

Who gets tossed out this week? Come on down, AOL (NYSE:AOL).

You've got flail
I've had an America Online account since the early 1990s. In other words, I'm a nerd. I was a consumer of most of the geek magnets at the time, spending time on Prodigy, CompuServe, and even as a co-sysop on GEnie's Investors Roundtable.

America Online took my breath away, though. It had a graphically rich user interface. It attracted a more mainstream crowd. I'm grateful for AOL, because if I wouldn't have stumbled onto The Motley Fool in 1994 -- when it was exclusive to AOL -- I wouldn't have been brought on board to the company a year later.

Oh, but that was 15 years ago.

AOL is no longer the cool place that it used to be. The same subscription service that peaked with 26.7 million accounts eight years ago had dipped below 5 million subscribers by the end of last year.

The defections are partly by design, as AOL once figured that it could back its way out of being a costly access provider and make up the difference as a wider ad-supported portal.

It hasn't worked out that way. Revenue fell by 17% in its latest quarter, with free cash flow taking a 39% swan dive.

It won't get any prettier.





$3.3 billion


2010 est.

$2.6 billion


2011 est.

$2.3 billion


Source: Yahoo! Finance. EPS = earnings per share.

AOL has held up well since being spun off by Time Warner (NYSE:TWX) two months ago. I'm guessing it's the value investors enamored by trailing results buying in, because AOL would have cratered as a growth stock.

The gradual fade will continue. AOL has done little to retain its access subscribers. It has actually been hacking away at the features -- including its proprietary newsgroup reader, personal webhosting space, and several other perks that have gone Obit City.

After years of turning up the heat on its paying usage base, it is now coming to the realization that freeloading outsiders don't monetize as well as the tens of millions of subscribers all but booted from the service.

Payback's a switch.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

  • United Online (NASDAQ:UNTD): One of AOL's biggest mistakes -- beyond turning its back on its subscribers -- is that it didn't just sell its access business to Earthlink (NASDAQ:ELNK) or United Online once it decided to let its flagship service slowly bleed to death. United Online runs NetZero and Juno. It's also struggling on that front, but the online workhorse also has Classmates.com, MyPoints, and FTD as cash flow beasts. United Online posted acceptable quarterly results last night. Revenue fell by 3%, but adjusted profits climbed 12%. It's not great, but it rocks when stacked against AOL over those same three months. Analysts also see generally flattish results in 2010 and 2011, again trumping AOL. The wild card here is Classmates.com. It has been sorely mismanaged, when it could have been the original Facebook. There is still time to fix that. In the meantime, patient shareholders are receiving a juicy 6.5% yield.
  • Google (NASDAQ:GOOG): AOL may be bellyaching over the 8% year-over-year dip in online advertising, but Google is laughing all the way to the bank. Google's latest quarter treated investors to revenue and earnings gains of 17% and 33%, respectively. Google stands alone. Revenue before traffic acquisition costs fell 8% in Yahoo!'s (NASDAQ:YHOO) latest quarter, matching AOL's slide. Google may be an AOL partner in paid search, but it's clear which of the two is worth partnering with in your portfolio.
  • Sirius XM Radio (NASDAQ:SIRI): It's hard to get excited about a subscription service going the wrong way. One can argue that AOL and Sirius were in the same boat early last year, when Sirius suffered net subscriber losses during the first and second quarters. However, the satellite radio provider did what AOL hasn't been able to do in eight years: It bounced back. Sirius XM hopped on the net subscriber growth train during the third and fourth quarters. Investors are believing again, with Sirius XM shares hitting a new 52-week high this morning.  

Sorry, AOL. I've been a customer forever but I just don't believe in you as an investment.

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Longtime Fool contributor Rick Munarriz wonders if he'll be the last AOL paying subscriber left standing. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.