Not Being Paid for the Risk in These Stocks

Investing in stocks is an intrinsically risky enterprise, but that's not necessarily a bad thing. In shouldering those risks, investors can expect to be paid a premium and generate higher long-term returns then they'd get by buying corporate bonds or government debt.

When investing, it is crucial to make sure you understand the level of risk you are taking on and then making sure you're being adequately compensated. (We recently took a look at the process that our equity analysts use to determine a stock's risk level.) But once you've determined the level of risk, how do you figure out what you're being paid to accept it? That's where valuation comes in. The riskier the stock, the cheaper you need the valuation to be. Just buying riskier stocks and assuming you are going to be paid more for holding them is a recipe for disaster.

We decided to run a screen to find some of these more uncertain stocks that investors should shy away from right now. Using the  Premium Stock Screener, we looked for stocks with a fair value uncertainty rating of at least high, with no economic moat, that have outperformed the S&P 500 so far this year (and thus may be on some investors' radar screens) and that hold a 1-star Morningstar rating. You can run the screen for yourself   here.

Media companies make up the majority (5/9) of the stocks that pass this screen. There are a few reasons for this. First, media has been the best-performing sector so far in 2010, rising 10.68%. The recovering advertising market is likely responsible for much of the jump. But in many cases the rise in stock price has not been warranted by the fundamentals--particularly when you consider that media is one of the most uncertain sectors today. As the Internet continually challenges old media business models, the profitability and even viability of many firms is called into question. In fact, we think that investors in several media stocks could likely be left with nothing.

Here are a few of the other firms that passed the screen:

 WebMD Health Corporation 
Fair Value Uncertainty: High | Year-to-date Return: +25%
From the  Premium Analyst Report:
WebMD has become the most popular online destination for health-related content. Although we believe certain long-term trends favor its business model, many risks remain.

 Netflix (NFLX)
Fair Value Uncertainty: High | Year-to-date Return: +126%
From the  Premium Analyst Report:
Netflix has attracted millions of subscribers and remains the leading player in the market for DVD rental by mail. We think the company's value proposition, loyal user base, and strong brand will lead to solid growth over the next couple of years. However, we don't think the company is well-positioned for the long run, as digital distribution of content has lower barriers to entry and will likely lead to new competitive threats.

 BankAtlantic 
Fair Value Uncertainty: Very High | Year-to-date Return: +21%
From the  premium analyst report:
BankAtlantic is a Florida real estate lender that has gotten itself stuck in an undesirable situation, in our opinion. For several years, it hummed along, generating decent growth and profitability. After 2005, however, a falling real estate market caused loan losses to start accumulating, branch expansion brought increased expenses, and profitability declined. In our view, the bank faces a number of headwinds that do not paint a pretty picture for shareholders.

Data as of 6/17/2010