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Sunday, June 14, 2009

5 Stocks You Should Avoid Right Now

A few weeks back, we profiled five unbelievably solid stocks -- companies that have been paying uninterrupted dividends to shareholders for more than 45 years. That consistency is incredible.

Today, we thought we'd take the flip side of that coin and examine five stocks that are anything but incredible.

Why they are so dangerous
What first caught our eye about these five dogs is that they are among the most heavily traded stocks on our major exchanges:

Company

Average Daily Trading Volume, Past Three Months

Recent Share Price

Citigroup

489 million

$3.48

Bank of America

507 million

$12.98

Ford

100 million

$5.98

Freddie Mac (NYSE: FRE)

15 million

$0.71

AIG

139 million

$1.61

Source: Yahoo! Finance.

Millions upon millions of these shares have traded hands -- on a daily basis -- over the past three months. That might make sense; after all, every one of these stocks has headlined the nightly news at least once during that time period.

Now, we have to acknowledge that many of these transactions were from the big-money institutions or the short-term day-trading crowd. But somewhere in there is the little guy.

And you should stay away
We believe long-term investors should avoid these stocks. Why? Because these five stocks have three troubling commonalities:

1. Convoluted relationship with the government.
According to the Center for Responsive Politics, the "Finance, Insurance, and Real Estate" industry spent more than $3.4 billion on lobbyists between 1998 and 2008 -- more than any other industry. Over that same time span, Ford and other automakers "donated" nearly $200 million to Washington.

What did those five companies get for all of those political contributions? All but Ford have received well-publicized bailout funds. And while the taxpayer money will be used to save these companies from a far worse fate (we hope), Uncle Sam's money comes with strings attached.

Under normal circumstances, businesses are accountable to three constituencies: their customers, shareholders, and employees. Businesses will do well when they do right by all of them. These five companies, however, are now accountable to a supra-constituency: the federal government. That frightens us, because it's unclear how customers, shareholders, and employees will fare when these companies try to do right by the feds.

2. Gordian knot-like financials.
Take a look at Citigroup's balance sheet. For all of the information, for all of the numbers, it's among the most confusing documents we've ever examined. Call us when you figure out what it owns and what it owes. Heck, call Citi CEO Vikram Pandit first. He may benefit from the knowledge.

See, it's seemed to us that as the credit crisis persists, insiders haven't been totally clear about what's on their books. Though some have a vague sense that mark-to-market accounting has forced them to write down asset values too far, only time will tell ... and time may not be on these firms' sides right now.

The auto companies have some of these same issues -- they have consumer finance/lending divisions -- but their pension obligations present an entirely different yet similarly complicated set of problems.

3. No near-term catalysts.
The financial companies will survive in some form -- our government has committed to that. But their future will be unlike their past. Regulation will be stricter. The massive 30-plus-times leverage that drove outperformance earlier this decade will be a dark relic of a bygone era. And now, skeptical investors may never ascribe the same market multiple to profits.

We just can't see a world in which these companies post the same kind of profits that we saw for the past 10 to 15 years.

What you shouldn't avoid right now
Contrast the future of Citigroup or AIG with, say, the future of these efficiently run blue chips, each of which is trading at a discount to its five-year average:

Company

Current P/E

Five-Year Average P/E

Motley Fool CAPS Rating

Abbott Laboratories (NYSE: ABT)

13.3

25.4

****

Diageo (NYSE: DEO)

12.2

16.4

*****

H.J. Heinz (NYSE: HNZ)

12.2

19.0

****

ABB (NYSE: ABB)

12.3

21.1

*****

Walgreen (NYSE: WAG)

14.9

22.4

****

Source: Morningstar and Motley Fool CAPS. CAPS rating out of a possible five stars.

This isn't a formal recommendation of these five companies -- and it's not to say that they each don't face challenges. But at least they're not encumbered by convoluted relationships with the government and convoluted financials. And they can continue with business as usual while the stocks in the previous chart are figuring out ways just to maintain.

Buy one-foot bars
Heck, there may be value in one or all five of the stocks we've advised you to avoid -- in some cases, they've more than doubled in recent weeks. But given their complexity, they're the proverbial "seven-foot bars" that Warren Buffett says he avoids in investing.

Instead, Buffett looks for "one-foot bars that I can step over." In other words, lay-ups, short putts, or fastballs down the middle (to diversify our sports analogy). These are easy investments where the reward profile far outweighs the risk profile.

1 comment:

  1. Thanks for your troubling commonalities information about five stocks now easily i can avoid this five stocks. Realy they are very dangerous.
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    ReplyDelete