Sometimes, the collapse of a small stock can provide insight into some larger themes for investors. Take Tuesday’s pummeling in the shares of the maritime shipping concern Frontline (NYSE:FRO), after the company missed earnings and the Financial Times ran an article saying Frontline may run out of cash as soon as next year. The stock fell about 41% on the news, closing at $3.06 on Tuesday.
Frontline traded as high as $38.85 in mid-2010, and it briefly surpassed $70 in the middle of 2008. Frontline’s debacle comes on the heels of last week’s news that General Maritime (PINK:GMRRQ) had filed for bankruptcy protection.
While Frontline is a small stock in terms of market cap, its meltdown offers three important lessons for investors:
Tanker stocks still aren’t worth the risk. This sector was being hit hard before the news of the past few days, and the headlines about Frontline have sucked the rest of the tanker names into an even deeper whirlpool. As Susan J. Aluise wrote earlier this month, tanker stocks are facing severe pressure from the combination of slow economic growth, a glut of capacity and falling rates.
This may look like the makings of a buying opportunity, since the elimination of players from an industry often sets up outstanding long-term investments in survivors that can take market share as prosperity returns. At some point, that’s likely to prove the case with other stocks in this group, such as Nordic American Tanker (NYSE:NAT), Teekay Tankers (NYSE:TNK) and Scorpio Tankers (NYSE:STNG).
For now though, the combination of enormous debt and tremendous fundamental headwinds indicate that there’s absolutely no reason to take on the headline risk — from either a trading or investing standpoint — until there’s a whiff of positive news for this group.
This is underscored by the weakness in TNK and other tanker names on Tuesday in the wake of the Frontline collapse.
Look at balance sheets first. The Frontline debacle may represent a theme we’ll see more of in 2012 if the slow-growth environment persists or worsens: severe underperformance for debt-ridden companies. Coming into Tuesday, FRO had $2.68 billion in debt versus $173 million in cash, and its debt-to-equity ratio was in the highest 5% of all stocks in the U.S. market.
There’s a lesson here: Right now, debt should be one of the first steps in investors’ due diligence. Any stock with the combination of a slowing core business and high debt may be in jeopardy of falling much further than you might expect. Frontline dropped from $20 to $10 in a little over two months during the summer — a decline that proved to be only a hint of what was still to come.
It’s still not time to bottom-fish. With so many stocks well off their highs of earlier in the year, there’s no reason to try to pick a bottom in lower-quality stocks. Sure, the market’s dicier names can provide beta in a bounce, but there’s also a risk of seemingly endless downturns. One need only look at the recent performance of the social networking sector, solar stocks, or such previously hot names as Netflix (NASDAQ:NFLX), Research In Motion (NASDAQ:RIMM) and Green Mountain (NASDAQ:GMCR), to name a few. In short, the only course right now is to avoid absolutely anything with warts — and Frontline is Exhibit A of why.
The bottom line: Frontline isn’t exactly a market barometer, but keep in mind that it sported a market cap of over $5 billion just over three years ago. On Tuesday, its market cap sank below $240 million. If nothing else, this debacle is a loud caveat emptor for anyone thinking about gambling on a stock with questionable fundamentals.
