The Bad And The Ugly

5/18/2009


Most of the stories printed in Dow Theory Forecasts offer advice about how to analyze stocks or recommendations of specific stocks to buy. This one is different.

Today we discuss shares of companies in such bad shape that you should avoid them. They have done just what their Underperform rating implies. Since we started using the Underperform rating in April 2002, an equal-weighted portfolio containing just our Underperforms would have fallen 43.2%, versus a 16.4% decline for the S&P 1500 Index.

The table below lists 12 stocks on our Monitored List with Quadrix® Overall scores of 20 or lower. Of those companies, just four earn Underperform ratings. Why don’t we award Underperform ratings to more of the ugliest stocks? Read on to find out.

Not surprisingly, many of the stocks with the weakest fundamentals are financials, dragged down by poor growth and eroding earnings estimates. Most low-scoring stocks have genuinely poor operating momentum, but we are reluctant to assign Underperform ratings for two reasons:

The federal government’s bailout and other policies make handicapping financial stocks’ performance more difficult. Many financials have surged in recent weeks — not because their outlook has improved, but because of positive news out of Washington. Our system of quantitative and fundamental analysis cannot handicap such government action.

Troubled stocks don’t always have to knock the cover off the ball to tack on gains. Many of the weakest companies — particularly financials — have been so badly pounded that even a glimmer of good news could lift the shares before the statistics considered by the Quadrix stock-rating system show improvement.

In general, the Forecasts recommends against selling stocks short, and not solely because of the two issues discussed above. The innate volatility and unpredictability of the weakest stocks, coupled with the stock market’s long-run upward trend, makes betting on a downward move risky. When we rate a stock Underperform, we are advising that you avoid it, not that you bet it will decline.

In the following paragraphs, we review some of the market’s uglier names.

This week, we bestow the dubious honor of an Underperform rating on Alcoa ($9; AA), which produces aluminum and a raw material used to make it. Sales of aluminum in the U.S. are likely to decline this year, just as they did in 2008. Aluminum prices are down more than 50% from June highs, and the combination of weak demand and ample supply should keep prices low.

Blame much of that weakness on two key end markets, residential construction and automobiles, with little chance for quick turnarounds. Despite a consistent decline in profit estimates, Alcoa has missed per-share earnings projections in the last three quarters. Alcoa is being downgraded to Underperform.


Ford Motor ($5; F) has tried to distance itself from its weaker rivals, and the stock has rebounded 119% this year. Overall, Ford has dealt with adversity better than the other two U.S. automakers, swapping debt for equity and apparently not touching its line of credit from the federal government. Ford raised another $1.4 billion by issuing 300 million common shares. While the company’s ability to raise capital is a positive, the stock offering dilutes the share base by 10%.

Ford still looks sick, with the recession aggravating chronic ailments. Ford has posted per-share losses in each of the last three years, and Wall Street expects per-share losses of $2.44 in 2009 and $0.39 in 2010. Persistent weakness in the automobile market is not helping matters. Ford’s 2009 sales have fallen 40% through April, compared to an industrywide decline of 37%. Ford remains an Underperform.


Options for General Motors ($1; GM) are dwindling as it nears a June 1 deadline to prove itself viable. The stock has plunged to a 76-year low, and it seems overvalued even at this price. Six top GM executives apparently think so as well — they have unloaded all their shares.

GM has proposed issuing up to 60 billion shares to pay off the federal government, the United Auto Workers union, and bondholders. Given GM’s current share count of about 610 million, the plan would give current shareholders just 1% of the company. Exacerbating the company’s woes, GM has yet to reach a stock-swap agreement with bondholders who have balked at exchanging their $27 billion claim for a 10% equity stake, currently valued at about $70 million. Bankruptcy appears likely. GM is an Underperform.

THE FORECASTS' UGLIEST STOCKS
——————————— Quadrix Scores * ———————————
– Total Returns –
Company (Price; Ticker)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
YTD
(%)
12
Mos.
(%)
Sector
Advice
General Motors
($1; GM)
6
15
3
19
82
0
3
(64)
(94)
Consumer Discret.
Underperform
Staggering operating losses and a looming bankruptcy. Take your lumps and sell before situation worsens.
Fifth Third Bancorp
($8; FITB)
9
32
7
5
8
22
3
0
(59)
Financials
Neutral
Bank has posted four consecutive quarters of operating losses, and profit estimates keep falling.
Freeport-McMoRan
($49; FCX)
6
6
9
4
71
83
6
101
(57)
Materials
Neutral
Global copper supplies are high and demand low. Sales fell at least 50% in last two quarters.
American Int’l Group
($2; AIG)
0
49
5
12
15
43
8
15
(95)
Financials
Neutral
Nobody knows whether this company will still be operating in a year, and the government already owns a big stake.
Alcoa ($9; AA)
2
27
21
27
17
34
8
(14)
(77)
Materials
Underperform
After seven consecutive quarterly sales declines, continued problems in the auto industry are the last thing Alcoa needs.
Motorola ($6; MOT)
10
13
9
9
96
87
12
37
(36)
Technology
Underperform
Motorola has lost its competitive edge and can’t get it back. Market share is eroding.
Citigroup ($4; C)
61
22
7
11
70
9
16
(45)
(84)
Financials
Neutral
Bank may not be up to the task of raising more private capital. Increased government control would not be good for shareholders.
Vornado Realty
($47; VNO)
38
20
27
34
11
32
16
(18)
(47)
Financials
Neutral
The real-estate market could remain depressed for quite a while, and both Vornado’s profit estimates and profit margins are falling.
Ford Motor ($5; F)
24
24
1
17
99
98
18
119
(39)
Consumer Discret.
Underperform
Sales fell 22% in Sept. quarter, 34% in December quarter, and 43% in March quarter. And demand for cars could decline further.
Dow Chemical
($17; DOW)
4
51
32
30
5
27
18
15
(56)
Materials
Neutral
Both sales and return on equity have fallen sharply in recent quarters, yet Dow trades at a premium to most peers.
Boston Scientific
($9; BSX)
34
34
15
26
66
34
20
16
(31)
Health Care
Neutral
Medical-device maker has had difficulty finding growth in recent quarters. A lot of rivals look better.
Southwest Airlines
($7; LUV)
12
46
28
50
13
20
20
(17)
(46)
Industrials
Neutral
Passenger revenue per available seat mile fell in March quarter, and Southwest expects worse declines in June quarter.
* Quadrix scores are percentile ranks, with 100 the best.

 

Low scorers take lead, but don't buy them
We derive Quadrix scores from dozens of statistics, and a poor Overall score generally indicates a stock has weak fundamentals. Such stocks tend to make poor investments — low Overall scorers have lagged the broader market by a substantial margin over the last 15 years.

Companies with weak fundamentals sometimes lead the market up during rallies. We have seen that phenomenon this year. However, such stocks rarely have the strength to sustain a rally.

Since March 11, a couple days after the S&P 500 Index hit its lowest point of the year, the lowest-scoring quintile of the S&P 1500 Index has gained 52%, better than the gain for any other quintile. However, the weak long-term returns of low-rated stocks suggests those gains will not last.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com