We get hammered every day with loud suggestions on a stock to buy right now that could make you a gazillionaire by lunchtime tomorrow. And that comes as no surprise since we tend to put a lot of energy and time into finding the best stocks to buy.
Just one toxic stock is enough to wipe out the gains from your winners.
Today, I’m correcting this imbalance. I’m here to show you the three stocks to never own. In fact, they’re so poisonous, I’m going to call them “Tim’s Toxic Stocks.”
And part of what makes these stocks profit poison is that they are some of the most popular on the market…
Why These 3 Toxic Stocks Are So Dangerous
When bad stocks become really dangerous is when they are popular enough to dupe people into buying them.
When the mighty hype machine of Wall Street gets behind a sinking company, those caught holding the bag can get hurt very badly. I have seen many times in my career what can happen when a great story with bad numbers is widely owned by individual investors.
Attila and his Huns were kinder to the Germanic tribes and Roman Legions than these stocks can be to your net worth.
We should spend as much time on avoiding poisonous companies as we do finding great new ideas to buy, but most of us don’t. The sad truth is that very few individual investors ever bother to actually review the financial statements of the companies they own. They rely on the brokers, advisors, and well-dressed slick-talking idiots on TV to do that for them. The unfortunate truth is that most of them have never read the damn things, either.
Instead, unsuspecting investors are buying stock in companies with deteriorating fundamentals. Their cash flows do not meet their expenses, so they will have to sell assets, raise debt, or sell more stock in the company to keep the lights on. Many of them have executive pay plans that make mob bosses look like paragons of kindness and restraint. They are using accounting gimmicks to cover up huge flags in the balance sheet and in the income statements.
The sad truth is that my toxic stocks are actually easy to spot if you look for them. But no one does, especially if the story is too good to pass up.
And owning these stocks is just too risky no matter how great the story may be.
They may become legitimate companies with outstanding prospects at some point in the future, but right now, the chances of them falling off the proverbial cliff is just too high to have them in your portfolio.
Fortunately for you, I do spend a lot of time reading financial statements. And I’ve found three duds with no business being in your portfolio, plus an entire industry I’m steering clear of…
The 3 Stocks to Never Own
Netflix Inc. (NASDAQ: NFLX) is a very popular company and has been a Wall Street darling ever since it buried Blockbuster.
I also love Netflix since it is the single best way to make sure my son stays in touch. I just change the Netflix password every few weeks, and he is sure to call within a few hours.
This will no doubt be one of my more controversial toxic stock picks, but the truth is that no matter how shiny the story is, the numbers tell me that it is too risky for most to us to own.
When we dig deep, we can see Netflix’s financial condition has been worsening. Reported earnings look fantastic, but the company is spending more than is coming in the door, so operating cash flow is actually getting worse. Total debt levels and interest expenses have gone up every year for the past six years as a result. So has the total number of shares outstanding as equity and option-based executive compensation plans dilute minority shareholders just a little more each year.
The stock may go up in the short term, especially if the company wins the cash-draining content war with Amazon.com Inc. (NASDAQ: AMZN), but the smart thing to do is to stand aside until the risk level has been reduced. The stock is trading at $257.54 a share, 92 times earnings and more than 60 times future earnings. Bad things happen from these levels all too frequently.
Square Inc. (NYSE: SQ) is another excellent story that makes the toxic list.
Square has done a good job of capturing some market share in small business payment markets, but it is not exactly a business with high barriers to entry. Banks will begin to fight back and regain market share, and so will other payments companies like PayPal Holdings Inc. (NYSE: PYPL). Share count and interest expense are both rising the past few years, as current cash flows are nowhere near what they need to run the business. The company is not profitable this year and fetches over 77 times the very much hoped-for 2019 earnings.
They may win the fintech wars against the world’s giant banks and become the Buster Douglas story of the financial markets, but that’s not the way to play it. The story is great, but the stock is just too risky for most individual investors to own right now.
Tesla Inc. (NASDAQ:TSLA) is one of the greatest stock stories of my lifetime, but it has no business in a portfolio.
We get driverless electric cars and a transportation revolution with a high-tech genius at the controls. However, we also get debt levels that are rising faster than an Ivy League graduate in the State Department and a genius who just might be completely out of his mind. The total share count has gone up every year since 2011, too.
It is a great story, but the stock is too risky for anyone who is not straight-out gambling on a long shot. We will have a widely owned all-electric driverless car someday, but I think it is more likely going to be a Ford or a BMW than it is a Tesla.
— Tim Melvin
Source: Money Morning