Beware These Toxic Stocks

BusinessWeek has an interesting story about Toxic Stocks: Beware These ‘Toxic’ Stocks

Bullish noises for the market abound. Fed Chairman Ben Bernanke makes it clear that he’s prepared to pull out all the stops to prevent economic collapse, and Treasury Secretary Henry Paulson is talking up broad investor-friendly reforms for market regulators. And, while still behind the fiscal curve, Congress is finally recognizing that emergency measures are needed to help alleviate homeowners’ pain and to help prevent a financial catastrophe.

With the close of a dismal first quarter, there hangs a faint whiff of optimism in the air over Wall Street. But a warning to investors ready to plunge into the market: Beware of land mines. Even if you think you know perfectly well which stocks are safe, the current market remains a beehive of hazards. Watch out, first of all, for “toxic” stocks that may appear enticing now, but could poison your portfolio at this critical stage of the market.

In investing, spotting stocks that could implode is as important as picking the potential winners. With the market as volatile as it is, it would be wise for investors to expect a surprise that could swing stocks skyward, in which case droves of investors would flood in, enthused to buy. But an equally compelling case can be made that the market will deliver a negative surprise, ensuring further chaos. Either way, it is essential to guard against “time-bomb” stocks, especially now when the market is displaying signs that the bull is ready to ram the gates.

“Although the absolute bottom can’t be determined, the amplification of volatility, panic, and fear has built a base (floor) in the major market indexes,” says Eric Parnes, managing director of Technomart Investment Advisors. The next move should be a “sustained rally that will challenge the highs the market established in August, 2007,” predicts Parnes, who is also editor of the market newsletter Shortex.

Certainly there are stocks to chase now, but emotion should be the last to dictate which stocks to buy. One factor that’s important to consider in ferreting out potential winners, as well as potential toxic stocks: plain old fundamentals.

Parnes argues that given such a parameter, investors should flee from, among others, Winnebago Industries (WGO), Valero (VLO), and Williams-Sonoma (WSM). Winnebago, the Iowa-based maker of self-contained recreation vehicles used primarily for leisure activities, is suffering from an earnings squeeze, says Parnes. It reported second-quarter earnings of 9¢ a share, a 67% drop from analysts’ expectations of 21¢. What’s crimping earnings are high inventory, a declining backlog, rising gasoline prices, and high borrowing costs. Now at $17 a share, just above its 52-week low, Parnes expects Winnebago to drop to $12.

Valero, the largest oil refiner in North America, is under pressure because of expectations that margins will turn sharply lower. The stock, now at $50 a share, could retest its previous low of $44, says Parnes. And Williams-Sonoma, a specialty retailer of upscale products for the home, owns Pottery Barn, West Elm, and Williams-Sonoma Homes. The company is among those suffering from the decline in consumer spending as a result of the housing slump, says Parnes, who expects the stock, now at $26 a share, to see $14.

Some of the department-store stocks should definitely scare away investors, says Georges Yared, president of Yared Investment Research, among them Macy’s (M), which operates more than 800 Macy’s and Bloomingdale’s stores, and Dillard’s (DDS). Now at $23, Macy’s is apt to fall to $18 as Yared expects 2009 earnings to drop to $1.70 a share.

I would like to add few homebuilder stocks (CTX, LEN, RYL, PHM), credit related (COF, DFS), retailer (NILE, BIG, MW), transport (YRCW) to the list. Infact all of the above make good short sale.