Three stocks we think investors should be wary of.
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This article originally appeared in Morningstar StockInvestor.
In tables, click Star Rating, Business Risk, and Size of Moat to see definitions of these terms. Definitions are hosted on Morningstar.com.
We calculate the Risk-Adj. Ret by taking a stock's fair value and assume it will grow at the company's cost of equity over the next five years. This is the stock's fair value in five years. We then subtract out the "risk" of the stock--defined as its cost of equity plus a margin of safety. All data below are as of Jan. 31, 2006.
We featured General Motors
This month, GM makes the list again, but this time we've added Ford
In the long run, GM's and Ford's success is largely contingent upon them striking a deal with the UAW. While one would think it would be in the best interest of its members for the UAW to cooperate, large unions have not always agreed to employers' demands. One needs to look no further than the legacy airlines like United Airlines and steel companies like LTV to see what happens when unions play hardball. Novak said, "The specter of Chapter 11 bankruptcy at either company remains a small, but real, risk that likely will increase with time."
We think investors would be wise to avoid these two stocks. Not only do they carry a significant amount of risk, they also lack any form of economic moat. Instead of representing ownership in vibrant operating businesses, these stocks today are little more than highly leveraged bets placed on the negotiating resolve of the union, future health-care costs, and the returns the stock market as a whole give to each firm's pension accounts.