Like it or not, most companies just don't have what it takes to last for decades. As an investor, if you want to avoid getting caught by next year's or next decade's bankruptcies, you need to start worrying about them now. What companies might they be? What will drive them to their deaths? Is there anyway for you as an investor to predict their fate and avoid getting caught in the catastrophe?
As a value investor, I'm always looking to find companies trading below their true worth. When I find one, I buy it. Then I simply wait for the market to work its magic and raise the company's stock to its real value, while watching for any signs that the firm's future may be in jeopardy, of course.
But to figure out when a business is trading below its real worth, we first have to determine what that real worth is. To do that, we start by estimating how much money the company will earn in the future. Then we take those future earnings and dial them back to their value today. Add all those dialed-back earnings together, and the result of all that figuring is a number that represents the intrinsic value -- the true worth -- of the company, and it forms the basis of our investing decisions.
For all that work to mean anything, the company we're looking at must be able to survive and profit into the future. If it can't earn what we think it'll earn -- or worse, if it goes bankrupt -- then all our figuring and calculating is for naught. So along with our projections for the next few years, we have to keep asking ourselves why our projections look realistic, and whether or not the company looks like it will even be around that far in the future and beyond.
The corporate grim reaper
Bankruptcy is a very real threat to companies and their investors, no matter how good a business's story may have once sounded. Independence Air just announced that it was not only bankrupt, but it would completely cease its operations, joining the ranks of airline has-beens like Pan Am and Eastern. Let's not forget some of the more catastrophic corporate failures of recent years, like Enron, Arthur Andersen, and WorldCom. Ford's (NYSE:F) big auto parts supplier, Visteon (NYSE:VC), is teetering on the edge of the same fate that recently claimed its counterpart, Delphi, in another industry where the overall economics simply look ugly.
Likely suspects
Just as there's no certainty that a stock will rise, until a firm actually files for bankruptcy, there's no certainty that its stock will plummet toward worthlessness. Yet there are key factors that you can use to help avoid the companies least likely to live through the decade. The biggest is infrastructure. If a company is tethered to an expensive infrastructure while competitors offer cheaper alternative services, there's a good chance it won't be around for the long haul.
Take Cincinnati Bell (NYSE:CBB), for instance. With its legacy wireline infrastructure and the associated high fixed costs, it's a relic from the days of monopoly phone service. Yet times have changed over the past few decades, and without a complete overhaul of its operations and cost structure, it probably won't survive the next decade. Thanks to competition from the likes of Motley Fool Stock Advisor pick Time Warner (NYSE:TWX), offering both VoIP telephone service and high-speed Internet over cable lines, along with the emerging trend of customers completely dumping their landlines and switching to all-cellular service, Cincinnati Bell's primary bread-and-butter business is under assault from all sides. Cincinnati Bell can't afford to raise prices to buttress its already-ugly cash flow -- any price hikes will just force an even faster erosion of its already shrinking line count. It's in an ugly situation with no easy way out, so I give it a high probability of bankruptcy by 2016.
Likewise, Blockbuster (NYSE:BBI) is high on my list of probable bankruptcies by 2016. Like Cincinnati Bell, Blockbuster is hampered by its high fixed-cost infrastructure -- its distribution system that includes thousands of storefronts and the inventory to stock them. The cable companies' emerging video-on-demand services offer a much better cost structure. After all, the movies are digitally and centrally stored and distributed over wires that are already paid for by basic cable rates. Adding to Blockbuster's worries, Netflix's (NASDAQ:NFLX) cheapest offering costs about as much as two Blockbuster rentals per month, making Blockbuster uneconomical for even moderate movie watchers. Not only that, but with companies like Wal-Mart (NYSE:WMT) constantly putting downward pressure on the price of buying DVDs, the question may soon become, "Why bother renting at all?"
The Foolish bottom line
With lower-cost alternatives pulling away at their core businesses, both Cincinnati Bell and Blockbuster are fighting for their lives. Neither of them seems to control its destiny at the moment. I wouldn't put it past either of them to file for bankruptcy by 2016.
With costs that high, futures that unclear, and competition that heavy, almost no share price is cheap enough to safely land below those firms' true worth. Suffice it to say, neither has made the cut as Motley Fool Inside Value selections, despite their apparently low stock prices. Sometimes what looks like a value may very well be a value trap. By looking toward the likely future, you can help yourself avoid many of those traps.
For further futuristic Foolishness, check out more stories about 2016.
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At the time of publication, Fool contributor and Inside Value team member Chuck Saletta had no ownership stake in any of the companies mentioned in this article. The Fool has a disclosure policy.
