Picking Stocks to Avoid

 | Jan 09, 2012 | 3:12 PM EST  | Comments
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Stock quotes in this article:

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By default, the focus for investors is finding attractive investment opportunities. The focus on finding attractive stocks begins to create a mental bias that urges investors to find something in which to invest. As a result, whether the market is an uptrend or downtrend, whether stocks are cheap or overvalued, the urge to make investments disregards trumps such considerations. The result is poor investment choices and loss of capital.

In investing, sometimes not losing means winning and winning big. Knowing what stocks to avoid is just as valuable as knowing what stocks to own. As the year kicks off, some popular or otherwise interesting stocks look very tempting. Yet investors would be well advised to put the investments in the too-hard-to-understand pile. If Warren Buffett can admit there are some situations he can't analyze, then that certainly means everyone else has even greater investment deficiencies.

By far one of the most tempting stocks today is Sears Holdings (SHLD), the retail holding company of billionaire investor Eddie Lampert. Lampert is often called the next-generation Warren Buffett. Lampert's investment success is without question. Many years ago, when shares were trading in the double digits, Lampert acquired more than 30% of the shares of AutoZone (AZO). With shares trading over $300, the success from AutoZone alone is enough to make an investment career.

After combining Sears and Kmart several years ago, shares in Sears Holdings zoomed past $150. Shares now sit at $29 as Sears continues to struggle with turning around the retail operations. Lampert has bought back over 50% of the company in the open market. With shares sitting at $29, the temptation is huge to now invest alongside Lampert. Yet I think Sears will continue to struggle as a retailer and there is nothing Lampert can do about that at the moment. While Sears' real estate assets are clearly valuable, monetizing those assets is quite difficult today. Aside from the tough real estate market, Sears has tens of thousands of employees that also stand in the way of that possibility. At $29, Sears looks very tempting and if the price gets any lower, my assessment could change quickly. Lampert is a shrewd businessman. But retailing is a tough business and Sears is caught squarely in the middle trying not only to compete with Wal-Mart (WMT), but other mall-based retailers like JCPenny (JCP), which is currently dealing with its own turnaround under activist investor Bill Ackman.

Altria Group (MO) is another name that looks tempting that could turn out to be a disappointment. The company's 5.7% yield is something that won't go away anytime soon, but cigarette use has been on a 10-year decline in the US. So far, Altria has mitigated the volume decline by price increases. And while cigarettes may have more price elasticity than other products do, continued cigarette decline will be an issue to contend with. Over the past three years, operating cash flows have declined from $4.8 billion to $2.7 billion. 

Even after falling from $118 to $42, OpenTable (OPEN) is best left alone. No amount of future growth justifies the current valuation of $1 billion, which is currently more than 40x 2010 free cash flow of $24 million. Online restaurant reservations are certainly a convenience for the customer, but it's not something any consumer will ever pay for, so the burden will always fall on the restaurant. That's fine except that its very easy to get in on the competition which is what OpenTable has from UrbanSpoon and countless other start ups wanting to do the same.

Indeed, if the market has a banner year in 2012, nearly all stock picks will look like good decisions. But any investors goal is the hopefully had good performing stocks in any environment. Just because a stock price has fallen off a cliff doesn't mean it has hit bottom. Cliffs can be higher than anyone anticipates. Avoiding investment losses is one way great investors excel because loss avoidance means your winners can carry a stronger impact on your portfolio. 

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