Stocks that aren't coming back

By Jim Jubak

No rational investor wants to buy a sinking ship. But that's exactly what some of us do in a bear market. Or, even worse, in the weeks and months after a bear market finally ends.

We go back to load up on the shares of the winners from the last bull market, ignoring evidence that some of these past winners have suffered so much damage that they'll never become profitable long-term investments again.

In my previous column, I wrote that picking good companies -- those that will come out of the current financial and economic crisis stronger than they went in -- is a key to long-term-investing profits.

The inverse of that is just as true. Avoiding the bad companies -- those in which this crisis has revealed long-standing weaknesses -- is a key to avoiding the losses that nullify the profits from your good picks.

Thinning the herd

With this column, I've culled my watch list to remove the stocks that won't come back (the remaining list is at the end of this column). I've tried to give enough detail about why I've dropped three stocks to enable you to go through your own watch list and eliminate the past winners that aren't going to reclaim their heights.

In this bear market, economic recession and global financial crisis, all stocks have gotten pummeled. Shares of good companies. Shares of bad companies. All stocks have sunk as if they were on one-way rides to hell.

Some companies, though, actually use these tough times to get stronger. Because they've been better-managed, they have cash and strategies that allow them to take revenue from their flailing competitors. These are the stocks you'll want to buy once this crisis is over, as I said in my previous column, "20 stocks worth watching."

Taking lessons from 2000-02

But other companies remain weighed down by bad management, overly aggressive expansion/acquisition plans, a mountain range of debt or underinvestment in core products -- or, worse, they have run aground. And instead of righting themselves when the stormy seas grow calm again, they will founder, victims of the damage inflicted by the crisis on a hull already weakened by rot.

These stocks may bounce back for a while once the crisis is over, but you don't want to own them for the long run. A bounce would be one last chance to sell before the ship goes under.

The bear market of 2000-02 was a truly painful time for many investors, yours truly included. But it was also an invaluable learning experience. Investors paid the tuition then. Now they should put those lessons to work.

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To illustrate, let's look at two winners in the great technology bull market that peaked in 2000, Cisco Systems (CSCO, news, msgs) and Nortel Networks (NRTLQ, news, msgs). Which would you rather have bought at the stock market low in October 2002? Both had crashed along with the rest of the technology sector in 2000. One came back strong. So strong, in fact, that in my previous column I added it to my watch list as a potential purchase after today's bear market ends. The other is reorganizing again and filed for bankruptcy in January.

At its technology-bubble market high, Cisco traded at $79.375 a share. The stock collapsed to an October 2002 low of just $8.60. By Nov. 6, 2007, trading at $34.08, the stock had recovered about half of what it had lost in the 2000-02 bear. An investor who had bought at the 2002 low would have been looking at a profit of about 300%. It's been all downhill for Cisco shares since November 2007, though, and the stock closed at $14.60 a share March 10. That's still a 70% gain from the 2002 low.

Bear not to blame for Nortel's collapse

At its technology-bubble high, Nortel traded at $870 a share. (The stock was the subject of a 1-for-10 reverse split in 2006.) The stock collapsed to a low of $4.50 a share Sept. 27, 2002. By Feb. 23, 2004, it had climbed back to $83.90. An investor who bought at the 2002 low would have been looking at a profit of 1,764%.

But shares of Nortel began to stumble long before the current bear market put out its claws. By Feb, 23, 2007, shares were down to $31.40. And then the real drop began. On March 10, 2009, the stock closed at 8 cents a share. An investor who bought at the 2002 low would have given back every cent of profit and then some. Anyone who bought Nortel shares at the 2002 low would have been looking at a loss of 98%.

Given the timing, a collapse in Nortel's stock beginning in 2004 and in revenue beginning in early 2007 can't be blamed on the bear market or recession we're in now. The company's revenue peaked at $11.4 billion in 2006, the last year the company managed to scratch out a profit -- just 2.5% of revenue. By 2008, revenue had declined to $10.4 billion, a drop of about 9%.

That wouldn't have been such a big deal if the company hadn't started bleeding cash again. In 2007, Nortel's cash flow from operations came to a negative $403 million. The company managed to keep its cash flow in the black only by raising $643 million in capital that year. In 2008, though, with the capital markets shut tight, Nortel's cash flow ran to a negative $1.14 billion. That was a huge deal for a company with $4.5 billion in long-term debt.

Continued: Simply not profitable

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