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 on to 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 one in five homeowners 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 on 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 -- a trend that is already being realized as American consumers saved 5% of their personal income in January. More importantly, consumers that do spend 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 apparel retailer Buckle (NYSE:BKE), for example, has certainly had to make adjustments in this new consumer reality, its financial health has long been much better than that of second-rate competitors like Gottschalks and Against All Odds, both of which filed for bankruptcy in recent months. Sadly, I don't think these will be the last second-rate retailers to file this 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 such as Urban Outfitters (NASDAQ:URBN) with double-digit profit margins than take a flier on retailers with negative profit margins like Finish Line.
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 Royal Caribbean Cruises (NYSE:RCL) this year -- it's 85% off its 52-week high. The cruise line operator hadn't generated any free cash flow for three years but was armed to the teeth with long-term debt -- to the tune of more than $6 billion at last count. Years of balance-sheet mismanagement are finally coming home to roost in this market, where large-scale credit necessary to construct and improve massive cruise ships is all but nonexistent. In order to shore up capital, Royal Caribbean joined fellow operator Carnival Cruise Lines (NYSE:CCL) and suspended its dividend last fall. While that move could keep the companies afloat (pun intended), it's not in the best interest of shareholders.
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 drug behemoths like Gilead Sciences (NASDAQ:GILD) and Amgen (NASDAQ:AMGN) that retain above-market-average multiples, but there are also plenty of higher-growth health-care companies trading at substantial discounts.
In a recent update of Motley Fool Inside Value, the team named insurance provider WellPoint (NYSE:WLP) an undervalued "buy" because:
WellPoint remains in good position to come out of the recession as a leading insurer with an attractive Blue Cross franchise. It's on solid financial ground with low debt and good cash flow.
If you'd like to hear more about what the team thinks of WellPoint, as well as other great places for newly freed-up cash, consider a free 30-day trial of Motley Fool Inside Value. To get started, please click here.
This article was originally published Nov. 21, 2008. It has been updated.
Todd Wenning is a "Dapper Dan" man, but he owns no shares of any company mentioned. WellPoint is an Inside Value recommendation. The Fool's disclosure policy is more than a feeling.
