An Avoidance Strategy

 | Nov 18, 2013 | 3:30 PM EST  | Comments
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Stock quotes in this article:

xom

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cvx

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ibm

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aapl

It seems like market-related chatter changes on a daily basis, from taper fears to a celebration of what portfolio manager Louis Navellier has called "QE to Infinity." Bad is the new good, and good is OK as well -- unless it's too good, and then it's bad. Traders are taking positions based on every whiff of Fed-speak or any economic headline, making dire or rosy projections that change with lightning speed. Amid all this, stocks keep going up regardless of silly little things like revenue, profit or asset value. It is, at best, a confusing time to be an investor.

I have no idea what the market will do over the next few days, weeks or months. I find myself in the camp with folks like Sam Zell, Seth Klarman and others who believe we are way ahead of fundamentals and economics, but I have no clue when the market will react to that fact. Conditions do not necessarily have to change by way of lower stock prices, after all. As unlikely as it seems, the equation could be corrected by improved fundamentals and a stronger economy. If you ever have to choose between risking your capital on a coin flip or my short-term market forecast, go with the coin. The odds will be substantially better.

I won't predict the market, but I will say that risk levels seem high and bargains are hard to find. In such an environment, it makes sense to use the tools available to find cheap stock with strong upside potential where there is danger of underperformance. One of the most valuable tools is the Piotroski F-Score. This system ranks changes in balance sheets, income and cash flow to measure the improvement, or lack thereof, in a company's financial position. A high score is good and indicates a strong chance of outperformance. In the current market, it makes sense to avoid any stock that scores less than 5 on the 9-point F-Score scale.

While I have been able to find bargains in the second- and third-tier energy companies, the giants of the industry appear to be struggling now. Warren Buffett may be buying Exxon Mobil (XOM), but the fundamentals indicate that last quarter's earnings decline may continue, thus pressuring shares. The stock has an F-Score of just 4. Chevron (CVX) is in worse financial condition and scores just 3. Profit and revenue for both companies were somewhat anemic in the third quarter and it doesn't look like this will improve soon. Both stocks are up in the double digits for the year, as the giant forced-allocation trade forces money into the indices, but these stocks are best avoided.

International Business Machines (IBM) is another stock that gets a lot of attention but should be avoided. The company has had six straight quarters of lower revenue. Lower tax rates and buybacks cannot continue to generate profit forever, and IBM appears to be running out of steam. It has an F-Score of just 4, and I see no valid reason to buy or own shares here.

With the exception of fantasy football, people have wasted more time and energy in the past year trying to guess what Apple (AAPL) would earn and where its stock might go. The stock has rewarded investors by pretty much doing nothing all year. If its F-Score of 4 is any indication, this is not going to change, and it may get worse before it gets better. Most investors are better off avoiding the shares, and the strongest attraction for the stock has been activist Carl Icahn pressuring for a buyback -- and that's not a valid reason to own the company.

I have no clue where the market will go, but I am well aware that based on long-term measures like CAPE ratios and market-cap-to-GDP ratios, we are on the high side of the ledger and some very smart people have expressed skepticism and concern about market levels. With that in mind, it makes sense to use the tools at our disposal to find stocks that are best avoided in this climate.

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