The best time to take a solid look at your stock portfolio is at the beginning of the New Year and that time is with us. In fact when looking at your portfolio you may even experience doubts and winces of discomfort as the bad memories of 2011 come flooding back - with the European sovereign debt crisis having all but smothered the anticipated economic recovery.
In fact those memories of 2011 will be even worse if you had any of the following massive losers in your portfolio, such as Office Depot (ODP), which ended 2011 with a 56% drop in value, Bank of America (BAC), which ended the year with a 57% drop in value and Eastman Kodak (EK), which was down by a whopping 85% by the end of 2011. Now I know many investors have been through this before, but now is definitely the time to set your investing goals for 2012 and an important part of that process is unloading any 'dog stocks' and avoiding investing in any further dogs through the year. However, I do know this can be a highly personal process for many investors, because at some time we all become emotionally attached to particular stocks for various reasons. In this article I have identified five stocks that I'd avoid in 2012. As always, please use my analysis as a starting point to conducting your own due diligence prior to making any investment decisions.
Sears Holdings Corp (SHLD)
Sears has long been a bastion of American retailing success and even as the ship started sinking prominent investors such as Francis Chou continued to jump aboard as well as the owner Edward Lampert, who continued to top up his stake. The question is how did the Titanic hit its iceberg? Well it all began when hedge fund manager Eddie Lampert used more than a little financial magic to conjure up Sears Holdings as a vehicle to unlock the huge value locked away in the vast real estate empire underlying Sears. Due to what we now know to be an illusion of guaranteed big gains to be made when this value was unlocked, investors piled into the stock, including some of the biggest name investors in the U.S., causing the stock to hit a high of $190 a share in early 2007. The stock has dropped a massive 82% since that high, and over the last year dropped by 54% to now trade at around $34. Sears has a market cap of $3.6 billion and a 52-week trading range of $28.89 to $94.79.
With the advent of the sub-prime disaster and the credit crunch, which pushed real estate values to new lows, it was impossible to capitalize on any value locked into the underlying real estate. These events also triggered a savage drop in consumer sentiment and discretionary spending that took Sears profits and margins with it. Sears now has a profit margin of -0.85%, which is far below competitors such as Dillard's (DDS) with a profit margin of 16% and Kohl's (KSS) with a profit margin of 5%.
This effect on margins can be seen in Sears' third-quarter 2011 financials, with earnings 7% down to $9.6 billion and net income down by a massive 188% to -$421 million. In fact the company's balance sheet also weakened with cash and cash equivalents falling in the third quarter by 7% to $632 million and long-term debt dropping by 3% to $2.3 billion.
Furthermore, when the company's low profit margin of -4% and PEG of -0.09 are considered, it seems that future growth prospects are virtually non-existent and on top of all this, despite Sears having a conservative debt-to-equity ratio of 0.59, there are fears that it will experience a liquidity crisis. This saw Fitch Ratings cut the company's bonds rating from B to CCC in late December 2011, reducing the company's debt to junk bond status.
In order to get out of this mess, the only apparent way forward for Lampert is to restructure the company to bring a focus back on profitability. But this will be an expensive process that will be costly and have a significant impact on earnings. The company has already announced plans to close 120 Sears Discount and Kmart stores and it's likely that with so many stores being closed and with further business restructuring to come there will have to be large write downs ahead, which doesn't bode well for future profitability. At this time the future for Sears is nothing but bleak and it will be some time before the company will start delivering value for investors again.
Research in Motion Ltd. (RIMM)
RIMM was once the darling of connectivity, a prominent feature of the corporate landscape and a status symbol for the business elite. Yet now RIMM's share of the smartphone market has dropped faster than a lead sinker. This all started with the introduction of Apple's (AAPL) now ubiquitous iPhone, followed by the growing array of Android smartphones that have entered the market since. Then we saw the explosion of tablet computing with the introduction of the iPad closely followed by Android and Windows-based tablets.
Since the advent of the iPhone RIMM has continually been caught flatfooted in counteracting this threat and even more so with the rise of tablet PCs and Android-based smartphones. According to Nielsen research, Apple leads as the top smartphone manufacturer in the U.S. with a 28.6 percent share, the Android-powered HTC ranks third with 15.8 percent, followed by Samsung (GM:SSNLF) at 10.4 percent and then Motorola with 10.7 percent of the smartphone market. The remaining market share is held by other manufacturers, amongst them RIMM. In fact this flat-lining market share can be seen when we look at RIMM's profit margin of 5.13% compared with Apple's 23% and RIMM's price-to-earnings ratio of four compared with Apple's P/E of 15. If anything the company's price-to-earnings ratio is enough to make one think the company is on death watch, and, in my opinion, make Research in Motion a buyout target.
RIMM has plunged 89% from its peak of around $148 in 2008, to now be trading at around $16 and this also represents a 75% drop in price for the last year alone. The company has a 52-week trading range of $12.45 to $70.45 and a market cap of $8 billion.
Surprisingly though third-quarter 2011 earnings were up 27% to $5.3 billion, which was the first quarter in the last five, where earnings have risen. However, the bad news continued on the profitability front with net income dropping by 16% to $269 million for this period, which was also a 71% drop in net income from third-quarter 2010.
So how did this once mighty and innovative communications and technology giant fall on such hard times? We can find some of the reasons in the attitude of co-founders and joint CEOs Mike Lazardis and Jim Balsillie. They seem to be hell bent on not letting go of what was the unique but now dated BlackBerry formula combined with producing almost unusable devices such as the Storm phone and the limited functionality tablet called the Play Book.
This failure to adapt to the market has seen long-term government and corporate contracts fall by the wayside as well as small businesses moving to use the iPhone or its Android brethren due to their simplicity. It seems to me that the technology has simply had its day, and this company is yet another innovator that failing to adapt to change, is about to head into the sunset. At this time the company seems destined to go the way of Palm, which was snapped up by Hewlett Packard (HPQ) at a bargain basement price only to be virtually shutdown.
It only gets worse when we start to dig into the company's fundamental indicators and see that it has a PEG of -1.67 and quarterly revenue growth of -6%, which show that prospects for profit and revenue growth are dismally low.
With a massively decreasing market share and an inability thus far to innovate new competitive products, the future for RIMM is indeed bleak, but there are many pundits who believe that RIMM will recover. I am not one of them and I certainly don't think we will see any solid investor value in 2012, other than some short-term reflexive trading opportunities. Overall I believe that RIMM is certainly on the slippery slope to obscurity.
Eastman Kodak Co.
Kodak is the company that has become so synonymous with photography you only have to mention the word photograph and instantly 'Kodak moment' pops to mind. Yet despite this, the company is literally on 'death watch,' with rumors swirling that it has commenced filing for bankruptcy.
In the last five years Kodak has dropped by a horrendous 98% to be currently trading at around 52 cents, which gives it a market cap of $140 million, and this once blue-chip stock now has the market cap of a micro-cap stock. So how did this tale of woe arise? Kodak despite being an innovator in the world of digital cameras - producing one of the world's first in the late1970s - failed to see the opportunity until it was too late and has now been hopelessly outclassed by the digital world, with companies like Olympus (OTCPK:OCPNY), Canon (CAJ) and Sony (SNE) dominating the digital camera market. In fact it appears that Kodak is going to go the way of Polaroid and becoming another leading innovator doomed to history.
Kodak's fundamental indicators certainly don't show us anything different. It has a profit margin of -15% as opposed to Canon's 8%. It also has a return on equity of -17% as opposed to Canon's 10%. Both of these indicators certainly don't bode well for a profitable future for Kodak and it is even worse when we see that Kodak has an earnings yield -882%, which is well below the risk-free rate set by 10-year Treasury bonds.
On top of all this three board members have recently hit the eject button, which is nothing but an indication of impending corporate doom. Furthermore, the desperation of the company only seems to be getting worse with the CEO discussing plans to sell a portion of the company's patents in an attempt to find enough money to keep the company afloat. With Kodak's margins and earning indicators it's only a matter of time before it plunges beneath the waves and becomes another object of corporate history.
Microsoft Corp. (MSFT)
Microsoft looks cheap and has for some time with the stock only rising by 0.4% in value over the last five years, to now be trading at around $28 with a price-to-earnings ratio of 10 and a market cap of $238 billion.
The company just seems to be permanently stuck in the $20 range and going nowhere. You can easily see that from its 52-week price range, which is $23.665 to $29.46. Furthermore, its stock price growth over the last five years hasn't even kept up with inflation and when we include the dividend yield of 3% it delivers a return that is marginally higher than the average annual inflation rate over the last five years.
In fact its stock price has only risen by 10% in value since 2002, yet the Standard & Poor's 500 (GSPC) has risen by 14% in value for the same period. In addition, the performance of many of Microsoft's competitors has been far stronger with Apple (AAPL) increasing by a massive 3,871% in value for that period and Google (GOOG) rising by 523% since it listed in August 2004.
The company pays a dividend, which has a current yield of around 3% and has a strong balance sheet with $12.9 billion in cash and cash equivalents, a 34% increase from the third quarter 2011. It also has moderate long-term debt of $12 billion, which has remained unchanged in the third quarter 2011, giving it a very conservative debt-to-equity ratio of 0.20. All of which bodes well for Microsoft's performance, yet its stock price just doesn't seem to rise.
While the company is certainly not on 'death watch' like some of the other companies I have analyzed in this report, it also isn't performing the way it should and it certainly isn't delivering investor value.
Office Depot has been in a tail spin for some time dropping by 56% in value for 2011, and since the start of 2007, it has dropped by a massive 94% in value to now be trading at around $2, giving it a market cap of $639 million.
Third-quarter 2011 earnings were up 5% to $2.8 billion and net income rose by 400% to $101 million for this period, which are quite impressive figures. It is surprising that Office Depot has seen both earnings and net income rise in an environment where we are seeing significant cost cutting by businesses and a reduction in spending on business supplies, but the impact of this may only become apparent when we see the income results for fourth-quarter 2011. Its balance sheet also strengthened during the third quarter, with cash and cash equivalents rising by 21% to $453 million and long-term debt falling by 0.7%.
So far so good, so what is there not to like about Office Depot? It becomes apparent when we start to dig into the company's fundamental indicators and it is there we start to see the company's weaknesses. Firstly it has quarterly revenue growth of -2%, which is lower than Staples' (SPLS) 0.5% and equal to Office Max's (OMX) -2%. Secondly it has a profit margin of 3%, which is lower than Staples' 5% but higher than Office Max's 1%. Third, it has a return on equity of 2.5%, which is substantially lower than both Staples' 14% and OfficeMax's 7%. When all of these factors are considered in conjunction with its PEG of -1.91 it is apparent that future growth prospects are extremely poor. I am also concerned by its debt-to-equity ratio of 1.36, which while not uncomfortably high does mean that it is using debt to finance its operations and if there is a rise in interest rates this will have a direct impact on its profitability.
Much of this lack of growth prospects, poor profitability and low margins can be attributed to the Office Depot model of running large one-stop warehouses and superstores, which have high costs when compared with an internet shopping portal or small, high-turnover shops.
Finally Office Depot currently has an earnings yield of 0.44%, which is roughly a quarter of the current risk-free rate of 10-year treasuries, indicating that at current prices the stock is significantly overvalued. This to my mind indicates that the stock can only drop further in price.
For all of these reasons I can only see Office Depot's stock falling further in value and it certainly doesn't appear to have any ability to deliver solid investor value during 2012.