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Overall, I am becoming increasingly optimistic about what lies ahead for the economy and the stock market in 2012. Despite the challenging economic events that are occurring around the world, we are seeing increased business optimism across the U.S. There are a lot of great companies in the stock market producing products and services, serving customers and paying dividends to shareholders.

However, it would be naïve to think it will all be smooth sailing, as many stocks are more than likely heading for a big fall in 2012. In fact, if you are holding any of the stocks among the list of S&P 500 top ten worst-performing stocks of 2011, you should be worried. These stocks include the likes of Bank of America (NYSE:BAC) with an annual return of -58%, Genworth Financial (NYSE:GNW) with an annual return of -51%, Alpha Natural Resources (NYSE:ANR) with an annual return of -60%, and MEMC Electronic Materials (WFR), with an annual return of -62%.

In the following article, I will analyze five stocks that have shown red flags lately in an attempt to see if they will crash and burn in 2012, just like the names above. According to my findings, I'd avoid Netflix (NASDAQ:NFLX), Green Mountain Coffee Roasters (NASDAQ:GMCR), Cabot Oil & Gas (NYSE:COG) and LinkedIn (NYSE:LNKD), but I'll offer that investors should hold onto Cisco (NASDAQ:CSCO). As always, use my analysis as a starting point for conducting your own analysis prior to making any investment decisions.

Netflix Inc is the nightmare on Wall Street. What happened to this once darling of Wall Street and its hyped-up future prospects? What concerns me most is that at its current prices, pundits are stating it is an absolute bargain buy poised for a recovery. Netflix has been in a tailspin for some time, dropping by 60% from its 2011 high of $304.79 attained in July 2011. The stock now trades around $124, with a market cap of $7 billion.

If you think this company is a bargain after its poor 2011 performance and its recent recovery from a bottom of $74.25, consider that even the Wall Street whiz kids know better than to talk up this disaster. Out of the 24 expert brokers tracked by Thomson/First Call, the median target price is $104, while the target high is $130. Yet the stock at its current price is well over the median target and not far off the high target. Even more concerning is the lowest target for Netflix, which is a paltry $45, so if you invested now and that target was hit, you'd be looking at a 64% loss. So what is the outlook for Netflix you ask, firstly let's see what the numbers tell us.

Fourth quarter 2011 earnings were up 7% to $875.6 million and net income dropped by 35% to $41 million for this period. The company's balance sheet strengthened during this period with cash and cash equivalents rising by 118% to $798 million, although long-term debt doubled to $400 million.

So far the numbers show that the company's performance has not been particularly strong, although when we start to look at its key performance indicators the outlook does improve somewhat. Especially in comparison to its competitors, as the table below shows.

Company

PEG

Profit Margin

ROE

Netflix

0.66

4.65%

60%

Amazon (NASDAQ:AMZN)

4.18

1%

8%

Trans World Entertainment (NASDAQ:TWMC)

NA

-4%

-1%

Overall based upon these indicators Netflix shapes up quite well especially in comparison to its competitors. Its PEG ratio of less than one indicates moderate growth prospects and it is delivering both a solid profit margin for a high volume product and a very impressive return on equity. In all of these areas it is also outperforming its competitors. I also quite like the company's debt to equity ratio of 0.62, which indicates that it is well placed to weather any further economic headwinds and is not overly exposed to cash flow leakage triggered by a rise in interest rates.

However, when we start to examine its business model and the execution of that model, a number of red flags become apparent. Netflix is a content selling company that is facing competition in a nearly saturated market using non-proprietary technology that is easily copied and utilized by other businesses in the streaming space. In addition, the company's management has consistently shown an inability to develop and execute solid business strategy. Notably with the bungled decision to split the company in two which was then reversed. There have also been ongoing losses of subscribers in the last quarter due to bungles made around content and pricing.

Overall I believe that this is a company without a sustainable competitive advantage, unclear business strategy and value proposition in a crowded and saturated market. All of which makes me believe that it is not in a position to deliver solid investor returns in 2012, as indicated by its historical performance, overwhelming analyst future outlook and its execution of business strategy thus far.

Green Mountain Coffee Roasters engages in the specialty coffee and coffee maker business. The company sources, produces, and sells approximately 200 varieties of coffee, cocoa, teas, and other beverages in K-Cup portion packs and coffee in traditional packaging. It sells its products primarily in North America through supermarkets, club stores, and convenience stores; in restaurants and hospitality; and to office coffee distributors, as well as directly to consumers through its website. Green Mountain has a market cap of $10 billion and a 52 week trading range of $37.58 to $1115.98. It is currently trading at around $66 with a trailing PE of 51. I don't believe that Green Mountain will deliver solid investor value in 2012 and now I will show you why.

The company's fourth quarter 2011 earnings were up 62% to $1.2 billion and net income rose by 39% to $104 million for this period, which are quite impressive figures. It is surprising that Green Mountain has seen both earnings and net income rise in an environment where we are seeing significant poor consumer sentiment and drops in discretionary consumer spending, but the impact of this may only become apparent when we see the income results for first quarter 2012. Its balance sheet also strengthened during the fourth quarter, with cash and cash equivalents rising by 130% to $93 million and long-term debt falling by 18% to $471 million.

So far so good, so what is there not to like about Green Mountain? The next step is to see what the company's fundamental indicators show, especially in comparison to its competitors. I have set these out in the table below.

Company

PEG

Profit Margin

ROE

Green Mountain

0.73

7.5%

15%

Peet's Tea and Coffee (NASDAQ:PEET)

2.30

5%

11%

Starbucks (NASDAQ:SBUX)

1.14

11%

29%

As we can see, Green Mountain is performing quite strongly, with moderate growth prospects as indicated by its PEG, which is superior to its competitors, a healthy profit margin which is only lower than Starbucks and a solid return on equity, which is again lower than Starbucks.

Of Green Mountain's key ratios the one that I don't like is its high debt to equity ratio of 2.40, which is my first red flag. This in my opinion indicates a heavily leveraged balance sheet, which brings a number of potential problems with it. If interest rates were to rise due to a sustained U.S economic recovery there will be impacts on cash flow and profits as the cost of its debt rises. Conversely if we were to see a double-dip recession, which affects the company's earnings it will also have a flow on effect on net income and also may lead to problems with debt covenants.

The rest of my red flags come from a report made by David Einhorn's Green Light Capital In November 2011. In summary the red flags raised were in relation to historical and intermediate-term cash flows being poor and a return on capital that is merely adequate and difficult to justify. Other red flags included Green Mountain's inability to rely on the protection of the two K-cup patents after September 16, 2012, profit cannibalization, it is the subject of a SEC inquiry and that the company has become a capital intensive contract manufacturer. When all of these are considered in conjunction with the fact that the company is competing in a small and highly saturated market place it is highly likely that the company won't b able to maintain its highly aggressive growth strategy.

Finally Green Mountain has an earnings yield of 2%, which is equivalent to the risk free rate of ten year Treasuries, indicating that at current prices the stock is overvalued. This to my mind indicates that the stock can only drop further in price. For all of these reasons, particular the red flags around patent expiry, market saturation and cash flow management lead me to believe there is little to any upside future for Green Mountain and that its price has formed a bubble. I can only see the company heading for a fall in 2012 to 2013.

Cabot Oil & Gas Corporation operates as an independent oil and gas company in the United States. The company engages in the development, exploitation, exploration, production, and marketing of natural gas, crude oil, and natural gas liquids. It has a market cap of $6.8 billion and is currently trading at around $32. The company has a nose bleed trailing PE of 47.

Cabot Oil and Gas was one of the market darlings of 2011, with its stock price almost doubling in value, but I don't see how the company can sustain its current price based on its key ratios let alone increase in value throughout 2012, and I will show you why.

Third quarter 2011 earnings were down 5% to $240 million and net income fell by a massive 48% to $28 million for this period. Its balance sheet strengthened during the third quarter, with cash and cash equivalents rising by 102% to $166 million, although long-term debt rose 10% to $1.2 billion.

Overall the financial performance for the last reported quarter is quite disappointing and this becomes further apparent when we examine Cabot's key performance indicators in comparison to its competitors, as set out in the table below.

Company

PEG

Profit Margin

ROE

Cabot

1.68

16%

7%

Exxon (NYSE:XOM)

0.28

8%

26%

ConocoPhillips (NYSE:COP)

0.43

5%

16%

Cabot's PEG ratio at 1.68 is extremely poor and indicates that there are very little to any growth prospects for the company through 2012, although it does have a solid profit margin, which is superior to both Exxon and Conoco. However, its return on equity is not particularly compelling and worse than both Exxon and Conoco. Cabot's debt to equity ratio of 1.07 while not poor does show that the company is more reliant upon debt rather than equity as a means of funding its operations. While it is not particularly heavily leveraged, I do prefer to invest in companies that are more reliant upon equity to fund their operations than debt, as this should lead to less volatile cash flow and net income with reduced problems arising from debt covenants.

Another key concern for Cabot's earnings is a recent Environmental Protection Agency report that linked the practice of fracking, which is used to extract gas underneath the water table, to ground water pollution. From an engineering standpoint the EPA report needs support for its conclusions. However, the report still creates headline and political risks. This will potentially lead to greater regulation that will have a direct impact on the future earnings of Cabot and other gas producers, thus curtailing growth.

Finally Cabot has an earnings yield of 17%, which is more than five times the current risk free rate of ten year Treasuries, indicating that at its current price the stock is undervalued by the market. Overall despite some very positive performance indicators, I do not believe that Cabot will deliver investor value investor value in 2012 and should decline in price, especially when it's decreased third quarter earnings are considered in conjunction with its nosebleed trailing PE of 47 and its expensive forward PE of 38.

LinkedIn Corporation operates an online professional network that through its proprietary platform, allows members to create, manage, and share their professional identity online. Its platform also provides members with applications and tools to search, connect, and communicate with business contacts, learn about career opportunities, join industry groups, research organizations, and share information.

LinkedIn debuted on the NYSE on 19 May 2011 with an IPO price of $45 and closed at $94.25, which was a 109% premium over the IPO price. This really was the litmus test in the trend of social network IPOs and to date it appears to have been successful. However, as an investor I am not a huge fan of companies that list on hype and gather stock price momentum, when they essentially don't produce anything of tangible value. It somewhat smacks of the valueless but sensationally hyped IPOs of the tech bubble from over twelve years ago that everyone seems to have forgotten about. So now I will show you why I believe that LinkedIn is set for a big fall in 2012.

Since its debut LinkedIn has dropped by 14% to be currently trading at around $81, with a market cap of $8 billion and sensational head spinning trailing PE of 1,109. It has a 52 week trading range of $60.14 to $122.70.

Third quarter 2011 earnings were up 15% to $139 million and net income fell by 135% to -$1.6 million for this period. Its balance sheet also strengthened during the third quarter, with cash and cash equivalents rising by 4% to $388 million and long-term debt remained steady at nil.

So far so good, so what is there not to like about LinkedIn? 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, especially in comparison to its competitors.

Company

PEG

Profit Margin

ROE

LinkedIn

3.12

2.3%

4%

Monster World Wide (NYSE:MWW)

1.74

5%

5%

Zynga (NASDAQ:ZNGA)

2.71

7%

NA

Based upon the key ratios compared in the table above, LinkedIn has poor to no growth prospects with an exceptionally high PEG ratio, which is also substantially higher than both Monster and Zynga. In addition, both its profit margin and return on equity are anything to write home about, with both Monster and Zynga having superior profit margins, but lower returns on equity. If the performance of Monster in 2011 is even a vague indicator for LinkedIn's performance in 2012, then it can LinkedIn in my view is certainly headed for a big fall, as in 2011 Monster's price dropped by 69% over the year. However, the one aspect of LinkedIn that I really do like is its debt free balance sheet, although if it is to sustain its current growth trajectory in the future it will need to examine the prospect of taking on some debt.

Finally, LinkedIn has an earnings yield of 0.09%, which is substantially less than the current risk free rate of ten year Treasuries, indicating that at its current price the stock is significantly overvalued. This to my mind indicates that the stock should drop in value to a more sustainable level. For all of these reasons I can only see LinkedIn stock falling further in value and it certainly doesn't appear to have any ability to deliver solid investor value during 2012.

If LinkedIn stock doesn't settle down to a figure that reflects its earnings, then it has attained bubble status. However, it is rumored that LinkedIn will be a takeover target of Microsoft (NYSE:MS) in 2012, as Microsoft plays catch-up with Facebook (NASDAQ:FB), in order to enter the social networking space.

Cisco Systems Inc designs, manufactures, and sells Internet protocol-based networking and other products related to the communications and information technology industry worldwide. It has a market cap of $108 billion and is currently trading at around $20, with a trailing PE of 17. It has a 52 week trading range of $13.30 to $22.34.

First quarter 2012 earnings were up 0.5% to $11.3 billion and net income rose by 44% to $1.8 billion for this period, which are quite impressive figures. It is surprising that Cisco 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. Its balance sheet remained stable during the fourth quarter, with cash and cash equivalents remaining at $44 billion and long-term debt remaining at $16 billion.

So far so good, so what is there not to like about Cisco? 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.

Company

PEG

Profit Margin

ROE

Cisco

1.36

14%

14%

Juniper Networks (NYSE:JNPR)

1.71

10%

6%

Hewlett-Packard (NYSE:HPQ)

1.60

6%

18%

Based upon the key ratios compared in the table above, Cisco has poor growth prospects, but they are better than its competitors Juniper and Hewlett-Packard. The company is also delivering a superior profit margin than both competitors and a solid return on equity although Hewlett-Packard's is higher. I also quite like Cisco's conservative debt to equity ratio of 0.36, which shows a solid balance sheet. This indicates the company is well positioned to weather any further economic headwinds and if the U.S economic recovery takes off and interest rates rise there should be little to no effect on Cisco's cash flow and profitability.

Despite setting out with the view that Cisco is headed for a big fall in 2012 and its less than appetizing PEG ratio, I am starting to believe that for 2012, CISCO is a stock to consider. Cisco is a dominant industry player with strong business alliances with a number of major business service companies including IBM (NYSE:IBM) and Accenture (NYSE:ACN). In addition, the stock stacks up quite well with a solid balance sheet with over $4 billion in cash and a moderately cheap forward PE of 10. Finally Cisco has an earnings yield of 6%, which is more than double the current risk free rate of ten year Treasuries, indicating that at its current price the stock is fairly valued, with a healthy risk premium over the risk free yield. I believe Cisco is a stock worthy of consideration for 2012.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: 4 Stocks To Avoid, 1 To Buy In 2012