Sell These Stinkers Before They Go Bankrupt

The single-worst argument I’ve ever heard for buying a stock — and I still hear it over and over despite history’s lessons — is that one should buy a name company when it’s selling for under a buck because “it’s a value” or “there’s not much to lose.” Wrong! There’s a lot to lose — as in 100% of your investment. Even worse, the nudniks who make these pronouncements buy heaps of shares because they are so inexpensive.

One of the current sucker’s bets is American Apparel (AMEX:APP). This is a prime example of why one must always invest carefully when it comes to retail. The company’s clothing isn’t anything special or unique, but instead is beholden to trends — and that’s never a good thing.

The company’s glory days of 2007, when the stock hit $15, are long gone. Back then, the company was making a profit. But by 2009, net income was barely a million bucks, and in 2009 — oh, my. In 2009, the company lost $86 million. That’s the problem with retail — this loss came on just a 5% drop in revenue, but when combined with a 6.5% increase in cost of sales and SG&A expenses that leapt by almost 9%, it torpedoed itself. SG&A had been significantly increasing year after year, so that should’ve been a warning. 2011 won’t be as bad — the company lost $27 million through the first three quarters — but that’s hardly reason to celebrate. Most years, American Apparel runs cash flow negative, and this past year has been no exception.

The reason why American Apparel is sunk, however, is that it carries $91 million of debt and is paying for it through the nose, with debt service approaching $28 million annually. The problem is that operations yield a net loss every quarter, which means debt must be paid out of an ever-dwindling cash stack, now down to $8 million.

The stock is at 85 cents. This isn’t a bargain, folks. It’s a bankruptcy waiting to happen.

At the other end of the spectrum is a company that has been around a very long time, has a few hundred million in cash, almost $8 billion in debt and makes more than a billion dollars in free cash flow annually. You might wonder how this company could ever go under. After all, Thomson Reuters (NYSE:TRI) is one of the premier news wire services with a long history and even pays a 4.6% yield. I’m not suggesting the company is going under in the next few months like American Apparel. However, I do believe there has been a secular change in the news market that will eventually doom it. I wrote about these changes in an article about newspaper stocks, and news wire services will not be immune, either.

The fact is more and more people are getting their news content from an ever-increasing number of sources. In most cases, the sources are just as good and even offer far more in-depth coverage on the journalism front than a news wire service ever could. The wires are intended to be bite-sized chunks of easily digestible nonsense. With the left-wing bias of all mainstream media sources being exposed on a regular basis, it’s only a matter of time before people realize they don’t need a wire service. The company’s tax software business doesn’t impress, either. There’s a reason TurboTax exists, after all.

So while Reuters isn’t going to disappear anytime soon, it will one day. I suggest opening a small short position. As for American Apparel, you can short that even at 76 cents and make an infinite return, rather than a 100% loss by buying.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned stocks.

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