After recently writing about stocks to use as "chicken shorts," I figured it was a good time to revisit the University of Michigan Ross School of Business and its monthly list of 100 "Earnings Torpedo" companies.
The school's Tozzi Financial Center has long put out a list of 100 stocks that students think will underperform the market based on academic research into principles like value, momentum, quality and predictability.
The center defines an "earnings torpedo" as a a richly priced growth stock whose price stands to plummet due to revised information about company's underlying fundamentals. This approach has worked very well in the past, as the center's top-100 list has underperformed the market in all but three years since 2001.
I usually write about this screen once or twice a year. When I last visited it back in July, small energy stocks and master limited partnerships dominated the list. Sun Edison (SUNE) -- which was then trading above $30 a share (vs. about 40 cents today) -- was also a potential torpedo.
Anyone who shorted MLPs and Sun Edison over the past year has obviously done pretty well, so it's more than worth reviewing the current list. Let's check it out:
Biotechs Don't Look Healthy
One thing really leaps out when you look at this month's rundown is that 67 of the 100 stocks on the list are in health care. And pretty much of all of those are smaller biotech stocks.
I understand investors' fascination with biotech, as these companies can change the world. In fact, many already have -- and there's enormous potential upside to them.
But the risks are enormous, and this is probably the easiest sector individual investors can lose money in. Successful biotech investing requires both stock-market expertise and highly specialized medical knowledge.
Anyone without that who's investing or trading in these stocks is simply gambling (with incredibly long odds). Frankly, those who make uninformed investments in small biotechs would have better odds playing keno. It's not something most of us should mess with using our hard-earned cash.
In fact, biotech had one of the saddest cycles that I saw on a regular basis during my many years as a stockbroker. The sector would get hot and investors would trade stocks based on charts, tips and news articles.
Many would decide they had this biotech thing wired and commit much or all of their portfolios to speculating on small-cap biotech plays. But of course, the cycle would ultimately turn and these stocks would all collapse, leading to devastating losses.
Read a few small biotech IPO prospectuses and you'll begin to get an idea of just how much you don't know about these companies -- and can't without specialized knowledge. So, this is one area of the market where I think it makes sense to find a fund manager with the right skill set, or even consider using an index approach.
Tesla Could Stall
The best known stock on this month's list is Tesla Motors (TSLA). The electric-car company has generated a lot of buzz lately by announcing 325,000 orders for its new Model 3. That's pretty exciting, as is the car itself.
However we should temper our excitement by the fact that even the most aggressive analysts don't see TSLA meeting all of that demand until at least 2018's end (and many think it will even take longer).
And while Tesla has so far not announced plans for any new debt or equity issue, Barclays analyst Brian Johnson thinks the firm might have to raise as much as $3 billion to finance the new car's rollout. He also believes we won't see significant Model 3 deliveries until 2019.
Also note that Tesla hasn't been profitable over the past 12 months. And even if the firm hits analysts' average earnings estimates for the next two years, TSLA is currently trading at 195x anticipated 2016 earnings and 80x 2017 earnings.
In other words, the stock is priced for absolute perfection -- and that's something rarely attained in the corporate world. One production delay or earnings miss and TSLA could easily turn into a "torpedo" and blow a huge whole in your portfolio. Consider Tesla's move today to recall 2,700 SUVs.
The Bottom Line
The Tozzi Center's students have done an impressive job with their "Torpedo Stocks" list over the years.
We don't have the space to cover all 100 of this month's 100 names, but it's probably worth your time to check things out here to make sure your portfolio doesn't contain any potential "uexploded ordnance."