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Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.

Overview

Seeing a stock priced at under $5 or $10 can often make it seem like a tempting buy. In my previous article, "Cheap Stocks Worth Buying Now", I looked at three stocks under $10 that I felt were currently worth purchasing. In this article, I will be reviewing three stocks that I think you should avoid buying. In determing why I think these stocks should not be purchased, I will be looking at each company's financial performance, current valuation, recent trading activity, earnings and future outlook.

Stock #1

Educational Development Corporation (EDUC) operates as a trade publisher of a line of children'’s books in the United States. The company operates through two divisions, one that focuses on distributing books through independent sales consultants and one that focuses on distributing books through book stores, toy stores, and specialty stores.

Financial Performance

Profit Margin (Trailing Twelve Months)2.09%
Return on Assets (Trailing Twelve Months)2.70%
Return on Equity (Trailing Twelve Months)3.80%
Revenue (Trailing Twelve Months)24.88M
Revenue Per Share (Trailing Twelve Months)6.31
Quarterly Revenue Growth (Year Over Year)-9.20%

As you can see from the numbers above, EDUC has low values for profit margin as well as its return on assets and return on equity. While the company's negative revenue growth is concerning, its quarterly earnings growth is even worse at -81.00% year over year.

Current Valuation and Recent Trading Activity

EDUC has a current price to earnings value of 24.0X and a price to book value of 0.9X with a negative earnings per share of $0.04 for the first half of 2013.

EDUC is currently trading at $3.12, $1.13 shy if its 52 week high and just $0.09 higher than its 52 week low. It is trading below both its 200 day moving average of $3.63 and its 50 day moving average of $3.26.

Earnings

Earnings for Educational Development Corporation have been nothing to write home about for quite a while. For Q2 of this year, earnings were just $0.02 per share, which was actually an improvement over Q1's reported earnings of -$0.06 per share.

Company Outlook

Educational Development Corporation seems to be heading in the wrong direction. Both revenue and gross profit have steadily declined since 2010. As far as I can tell, the company has not done anything to reverse this trend.

EDUC's quarterly dividend has decreased from $.40 per share in 2008 to its current dividend of $0.08 per share. With a payout ratio of 338%, I'm confident that more cuts or even a suspension of its dividend is on the horizon. Because of the company's poor financial and market performance, I recommend not adding EDUC to your portfolio.

Stock #2

ARMOUR Residential REIT, Inc. (ARR) invests in residential mortgage-backed securities, primarily those issued or guaranteed by a US government entity.

Financial Performance

1 Year Earnings Growth Rate-24.0%
Return on Assets (Trailing Twelve Months)1.23%
Return on Equity (Trailing Twelve Months)12.00%
Revenue (Trailing Twelve Months)368.3

Net income for ARR went down in Q1 of this year compared to Q4 of last year (102M vs 116M).

Current Valuation and Recent Trading Activity

ARR has a current price to earnings value of 4.7X and a price to book value of 0.6X with earnings per share of $0.97.

ARR is currently trading at $4.52, $3.46 shy if its 52 week high and just $0.38 higher than its 52 week low. ARR has seen a fairly steady decline in stock price since its 52 week high back in August of last year.

Earnings

I'm not sure when the last time ARR reported earnings that actually beat the estimate, but it has missed its target significantly the past three quarters. The past two quarters, earnings have missed by $0.05 per share. Earnings missed by $0.03 per share the quarter before that.

Company Outlook

ARR's earnings have decreased from $0.31 per share in 2012 to $0.23 per share last quarter. $0.20 per share is expected for the company's next reported earnings statement, but it wouldn't surprise me if it misses expected results for a fourth straight time. When earnings decrease, a company's stock price often follows, which is exactly what has happened to ARR.

With the fluctuating nature of the REIT industry, there is always a chance that ARR's future could turn positive, but I wouldn't bet on it. The company's inability to stop its drastic drop in earnings and its continuing reduction of its monthly dividend (the lone attractive benefit of this stock) from $0.12 back in 2011 to $0.11 to $0.10 to $0.09 to $0.08 and now $0.07 per share should give pause to any one who is considering investing in this company's stock. In my opinion, this stock should be avoided until there is some news that the management team can turn things around.

Stock #3

Diana Containerships Inc. (DCIX) is a shipping company primarily focused on seaborne transportation of container cargoes. It owns and operates a number of vessels and containerships.

Financial Performance

Profit Margin (Trailing Twelve Months)-46.69%
Return on Assets (Trailing Twelve Months)1.65%
Return on Equity (Trailing Twelve Months)-13.76%
Revenue (Trailing Twelve Months)59.32M
Revenue per Share (Trailing Twelve Months)2.03
Quarterly Revenue Growth (Year over Year)21.60%

DCIX just recently announced a net loss of $5 million for Q2 of 2013 along with a decrease in time charter revenues compared to the same period last year.

Current Valuation and Recent Trading Activity

DCIX has a current price to earnings value of 23.7X and a price to book value of 0.7X with earnings per share of $0.19.

DCIX is currently trading at $4.15, $2.98 shy if its 52 week high and currently at its 52 week low. It is trading below both its 200 day moving average of $3.63 and its 50 day moving average of $3.26.

Earnings

Earnings for DCIX are not good, plain and simple. For Q2, they just reported a negative earnings per share of $0.02. Prior to this quarter, wasn't much better with EPS reports of $0.03, $0.01, and $0.05 in the prior periods. The EPS estimate for Q3 is even worse than the reported -$0.02 for this quarter.

Company Outlook

In addition to the poor revenue and earnings reported for Q2, DCIX announced that its next quarterly dividend will be cut in half. It will pay $0.15 per share as opposed to the prior dividend of $0.30 per share. At the time of writing, DCIX is down 8% on the day in wake of this news.

I don't see any silver lining to the cloud that is DCIX's future. The shipping industry continues to remain in a state of uncertainty with demand still down from previous highs. While some companies (like NMM) have been able to make adjustments and remain in a state of stability, Diana Containerships hasn't fared as well. In my opinion, this is a stock to stay away from as there are better companies to invest in if you are looking at the shipping sector.

Conclusion

Poor earnings, check. Lack of growth, check. Slashed dividends, check. The three companies reviewed above are all struggling and I don't see any evidence that leads me to believe they won't continue to struggle in the near future. In my opinion, these stocks are not worth buying as they have few opportunities to increase an investor's assets over a significant period of time.

Source: Cheap Stocks To Avoid: Round 1