Sell These Stinkers Before They Go Bankrupt

by Lawrence Meyers | January 9, 2012 7:00 am

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[1]). This is a prime example of why one must always invest carefully when it comes to retail[2]. 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[3], 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[4]) 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[5], 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[6] 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.

  1. APP:
  2. one must always invest carefully when it comes to retail:
  3. American Apparel is sunk:
  4. TRI:
  5. in an article about newspaper stocks:
  6. in-depth coverage on the journalism front:

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