It's true that the market tsunami has left some dirt-cheap value stocks in its wake, but if you don't have the cash to buy them, the opportunity will pass you by. Now is the time to go through your portfolio to see what you can sell to raise some cash.
Yes, many of your stocks are already trading for a loss, and yes, "buy high and sell low" is the exact opposite of how you're supposed to invest, but in today's market, selling weaker companies for a loss and reallocating the money to better investments is a sound strategy, for it will be the best-run companies that survive this storm and thrive when the market turns for the better.
At a time when you can find so many cheap stocks, it makes no sense to hold onto companies facing enormous headwinds just because they are discounted. So here are two investments to consider selling in this market and one idea for where to put your money.
Second-rate consumer services companies
With unemployment on the rise, credit card companies slashing credit limits and raising rates, and more than 7.5 million people underwater on their mortgage, the U.S. consumer is in a bad place right now with no sign of recovery in the short run.
This isn't just a cyclical spending slowdown that will take months to work itself out, either. The $6.2 trillion in debt that U.S. households took out between 2000 and 2007 fueled much of the consumer-related growth we've experienced in the past decade -- on SUVs, flat-panel TVs, and granite countertops and other luxury goods. This massive debt burden will need to be paid down before a healthy recovery can occur.
To achieve this, households will be saving more and spending less. More importantly, when they do spend they will not only be more price-conscious but more selective about where they choose to do their spending. Put simply, the stronger companies will survive, while the weaker ones will fall further. If you own the latter, they should be the first to sell from your portfolio.
While Best Buy (NYSE:BBY), for example, is naturally suffering in this climate, its financial health has long been much better than that of its second-rate competitor, Circuit City, which filed for bankruptcy earlier this month. Sadly, I don't think Circuit City will be the last second-rate retailer to file in the coming year. The market will naturally punish inefficiently run businesses, and in this market, you don't want to be betting on the weak horse.
So, ask yourself, "Are the consumer stocks I own the best-in-class?" If you're not sure, look at their margins and sales growth versus competitors and the industry at large. Along these lines, I'd much rather back top-notch names like McDonald's (NYSE:MCD) and Yum! Brands (NYSE:YUM) with their 26% and 12% operating margins, respectively, than Wendy's/Arby's Group's miniscule 5% margins.
Companies with high debt and no free cash flow
Similarly, you want to get rid of companies with excess debt on their balance sheets and negative free cash flow. When sales and earnings are down, fixed costs like interest expenses and rent payments become even more pronounced. Without free cash flow generation, the company must burn through the cash on its balance sheet, sell assets, issue stock, or borrow even more money just to make do. This is not a winning formula.
Just look at what's become of Las Vegas Sands (NYSE:LVS) this year -- it's more than 95% off its 52-week high. The casino operator hadn't generated any free cash flow in years but was armed to the teeth with long-term debt -- to the tune of $10 billion at last count. The company's solution, announced last week, was to issue an additional 181.8 million common shares to raise $1 billion -- diluting existing shareholder value in the process. A similar story of shareholder woe has also played out at Advanced Micro Devices (NYSE:AMD).
Bottom line: There's no reason to hold onto an over-leveraged company with no means of paying its debt other than at the expense of shareholders. If you own a company like this, consider selling it to free up cash.
What to buy
Even though selling for a loss may wound your pride -- no one likes to admit defeat -- you're better off sacrificing the battle to focus on winning the war. That means reallocating capital from poorly-run companies facing extreme headwinds and putting it behind well-run companies with the wind at their back.
One industry you should consider putting money behind is health care, which will benefit from the aging of baby boomers in coming decades. And talk about timing -- this market has provided us with an opportunity to buy great health care companies at great prices just as baby boomers enter retirement age. Sure, you can stock up on behemoths with hefty dividend yields like Pfizer (NYSE:PFE) and Johnson & Johnson (NYSE:JNJ), but there are also plenty of higher growth health care companies trading at substantial discounts.
In the most recent issue of Motley Fool Inside Value, the team named Quest Diagnostics a "great buy" now because:
It already benefits from the increased number of medical tests taken as we age, and that will only improve with the use of preventative measures to reduce health-care costs. Quest is a leader in innovative new tests, which carry higher profit margins. The company has paid down $435 million in debt so far this year, and it should pay down more over the next two years.
If you'd like to hear more about what the team thinks of Quest Diagnostics and other great places for newly freed up cash, consider a free 30-day trial to Motley Fool Inside Value. To get started, please click here.
Todd Wenning congratulates his beloved Cincinnati Bengals on their recent tie against the Philadelphia Eagles. (Hey, at least they didn't lose again.) Todd owns shares of Pfizer, but of no other company mentioned. Pfizer and Johnson & Johnson are Motley Fool Income Investor recommendations. Pfizer and Best Buy are Inside Value picks. Best Buy is a Stock Advisor recommendation. The Fool owns shares of Pfizer and Best Buy. The Fool's disclosure policy is more than a feeling.
