The Dirty Dozen: 12 stocks with Fundamentally Broken Business Models

The Dirty Dozen: 12 stocks with Fundamentally Broken Business Models

After weeks of exhaustive research uncovering the industries and companies that are in the most trouble right here, right now, I’m proud to release my latest investment book to you dear TradingWithCody subscribers.

The new book is called “The Dirty Dozen: Twelve Stocks with Fundamentally Broken Business Models”.  You can access the book on the site at this link:

Or you can email us requesting a PDF copy of the report at and we’ll send a PDF of the report back to you via email.

Here’s the intro:

I’ve laid out the case for 12 different companies and different business models that are geared for a reality that has already passed us by. These are brand new names that myself and my crack team have done a thorough top-down analysis on, and I haven’t shared any of them yet with my readers.  Each of these stocks generates revenues and profits by engaging in activities that I essentially consider to be run-off operations.  The managements of each of these stocks are unwilling (or unable) to realize just how at risk they are, and I’ve selected companies that are highly unlikely to pivot into a new direction.  This isn’t a book about some syllogism like “If the Euro breaks up, then…..”,.  This is about huge long term secular trends and companies that are dead in the water.  And it just happens that there’s a nice macro crisis that should catalyze their demise.

Most investors, especially retail ones are hugely levered to the long side.  And I’m not just talking about your stock or bond portfolio.  If you own a house, have a job, have income producing property or anything that does better when the economy is booming, then you are naturally extra long.  To balance that out I’ve picked companies that will give you long-term exposure to not only their own flailing prospects but ones that should show some nice returns if the larger market falters.  The shifts in thinking and reality that underpin my choice of these stocks are along some of the same lines I’ve been talking about for years, themes that have helped my readers hit plenty of doubles & singles and even some homeruns.  I’m talking about the Cloud Revolution, the App Revolution and the upheaval in the financial world; these are all huge negatives for our dozen picks aka positives for us.  So right now, in this moment of calm before the storm, it’s a great time to read up and add some exposure to the short side of businesses that can’t possibly survive in the Brave New World.

Every business, no matter how great, at some point becomes not so great.  Technologies change, laws shift and secular progress will take place regardless of how hard you try to stop it.  And lest you think that you’re smarter than the average bear and will always recognizes problems, take the case of one Warren Buffett.

In 1970 the Sage of Omaha bought Blue Chip stamps, a company that issued loyalty rewards that companies could hand out to customers to incentivize them to keep coming back.  Warren has remarked “When I was told that even certain brothels and mortuaries gave stamps to their patrons, I felt I had finally found a sure thing.” In 1970 there were 60 billion stamps in existence and the company had $126 million in revenue, about $700 million in today’s money; by 2005 that was down to $25, 920.  That’s barely enough to charter one of Berkshire Hathaway’s Netjets for a weekend, let alone move the meter on a company with $100 billion in revenue.  If Warren Buffett, the most legendary stock picker in history can make the mistake of not seeing where the world is headed, so can anyone.

Don’t despair though, there are ways to get through this.  There are always signs when a business is headed downhill, such as whether they can’t pivot to a new technology, or management is stubbornly convinced that they need to fight old battles.  Over the last couple years finding short cases has become an increasing part of what I do and we’ve had several substantial winners.  In the case of A123 systems I targeted a company with a blazing hot IPO that was nothing more than shell to funnel off taxpayer money.  Here’s what I said in December of 2010, before AONE’s 75% decline.

From the book  “14 Stocks That Should Double in 2011 (and 6 That Should Collapse)”:

Many of the targeted tax tricks, i.e., welfare, for these alternative energy companies are going the way of the dodo in coming quarters. It will be a very tough proposition for the politicians to extend and/or create new subsidies — though they do sneak some in every tax package that gets passed. Speaking of which, this stock and many others of the alternative energy companies that depend on those subsidies to stay in business, have rallied as the Republican/Democrat Regime come to pass their latest convoluted, but decidedly pro-business/pro-energy tax package.

In any case, these heavily-subsidized alternative energy companies need to have already established steady businesses and customer bases and profitability in these generous times, and this is one that is far from getting there. That said, the company’s got more than $4 per share in net cash, and even though the company’s burning lots of cash and had to admit that their customers are pushing out orders into next year, I probably will cover the stock if and when it falls back into the $5-$6 range, where it was soon after we shorted it the first time. I’d put a $11 or $12 stop loss on the short, just in case the stock goes bubblicious before it goes ugly.

CompanyDate We PublishedPrice When PublishedPrice Now%Gain

AONE – A123 Systems                12/15/2010                  $9.04                                             $2.29                           75%

Source: Yahoo Finance

In the case of Lender Processing Services (LPS) we spotted a company that was not acknowledging the huge legal cliff is was about to run off. In this report we talk about a company very much related to LPS that we think can match the 55% fall its seen since first wrote about it. 

From  the book “14 Stocks That Should Double in 2011 (and 6 That Should Collapse)” (new version):

LPS collects fees from referrals to the robo-signing services and legal mills that have exacerbated the latest crisis. Law firms that took their time with mortgage documents have seen their contracts terminated by LPS. LPS went so far as to setup a robo-signing operation for a client. And perhaps the greatest liability to LPS is that people are starting to look at their mortgage documents. This means that LPS could be on the hook for even performing loans, not just ones sloppily handled in bankruptcy court.

Just like the banks of the last decade, LPS has vertically integrated exposure to the housing market. LPS has been pitching itself as countercyclical and insulated from any putback nightmare scenario. Management has gone so far as to claim that a protracted foreclosure mess could benefit the Company. On it’s most recent earnings call, in response to an ongoing investigation by the Office of the Comptroller of the Currency, CEO JeffCarbiener stated “I just discussed and as previously disclosed, we have expressed our willingness to fully cooperate with any and all inquiries. We also continue to believe that the ultimate outcome of these inquiries will not have a negative material impact on our business or the results of operations.” Has a certain ring of Paulson’s “subprime is contained” doesn’t it?

With a stock price up 15% year-to-date, an LPS short offers the most effective equity exposure for playing the next leg of the housing mess. Shorting banks while they’ve been given a license to hide losses and print money by borrowing for nothing from the discount window has been a break-even proposition for us, despite the booming markets. I think we have an even purer play on the mortgage fraud/robo-signing/foreclosure fraud mess.

CompanyDate We PublishedPrice When Published Price Now%Gain

LPS-Lender Processing Services  3/10/2011                    $32.80                                           $15.02                         54%

Source: Yahoo Finance

With Research in Motion (RIMM), the case is very different, they actually make a useful product and are amazing innovators (the co-founders practically invented mobile email).  But their refusal to accept that Apple had built a product that everyone wanted cost their shareholders ten of billions of dollars.  When I first told the readers of my book “50 Stocks for the App Revolution” to stay away from RIM the company hadn’t yet begun its 75% slide:

From the book “50 Stocks for the App Revolution”:

Apps and all things related to apps are in a huge growth cycle, and that while RIMM’s rightly been punished for losing market share in the smart phone market, especially in the US, it’s still going to show growth over the next few years — despite continuing to lose smart phone market share along the way.

The virtuous cycles that critical mass brings to a tech company, has recently ended for RIMM. RIMM had critical mass for the enterprise email solutions for a decade, but the technology has been creatively destructed by the very similar and more flexible (though still slightly less reliable) email/message/social-networking capabilities of the iPhone and Android…which, as I wrote yesterday, are just starting to see the virtuous cycles that come from critical mass.

How do you know when a company’s got critical mass, or for that matter, when they’re starting to get it or when they’re losing it? There’s not set formula, of course. You’ve got to watch the trends, the technologies, the companies, the consumers actions and where the developers are going.

CompanyDate We PublishedPrice When PublishedPrice Now%Gain

RIMM – Research in Motion        11/20/2010                   $58                                                    $16                              73%

Source: Yahoo Finance

So why did I write this report & why is it so important right now now? First off, there is no such thing as a bad stock, just bad a price.  At some level everything has value, it all depends what you pay for it.  But in all the cases I’ve outlined, the market is still willing to support these broken businesses, often at multibillion dollar valuations. If you look at some of the metrics I’ve pulled for you you’ll see some big cash flows and fat dividends; unfortunately for these stocks those numbers reflect a past reality, not the shifting future.  The stock market is the ultimate objective judge and arbiter of value and the point is that we can make money getting out of and getting short these names before everyone else gets it.

But that alone isn’t enough; bad businesses can stay expensive for years—just ask anyone who tried to short the housing bubble before it ultimately collapsed.  Timing is everything and the timing to target this Dirty Dozen is now. We are at the crossroads of huge technological, financial & regulatory shifts, many of which are well past their tipping point. Enormous tectonics moves have already taken place and lots of the low-hanging fruit has already rotted (think Blockbuster, Fannie & Freddie) but there is so much more yet to collapse.  The world is never going to back away from iphones and remote data, so you need to avoid companies that are clinging to revenues that will be disrupted by the App and Cloud revolutions.  You need to avoid investing in financial companies that have been living off the fat of government welfare and by exploiting the poorest in society; their ability to leverage shady practices is coming under more scrutiny than at any time in the past 50 years.  And most of all you need to protect yourself from complacency and think about your portfolio of stocks in terms of owning whole businesses.  Given the entire spectrum of the investment world would you really want to be the CEO of a student lender? A radio analytics company? A financial company that can be regulated out of existence?

I wrote this book to help you avoid industries and businesses that have seen the world pass them by, and to make money by getting short uninformed optimism.

I am extremely worried about the ability of neer-do-well politicians to take us right back to 2008.  Instead of using the crisis to fix long-standing problems they are negotiating minisculue bond haircuts & debating legal arcana.  And that’s why I wrote 

The Dirty Dozen: 12 stocks with Fundamentally Broken Business Models,

so that we can act even if the bureaucrats won’t.

Don’t get me wrong, I’m a fundamentally optimistic guy, and I think a lot of really great things are happening in the U.S. economy, but there are signs that any error or mini flash crash or hummingbird flapping its wings could send the stock market into another tailspin.  When I hear money managers starting to believe central bankers, I get worried.  Really smart people are significantly under pricing just how quickly credit can dry up. And that when banks stop trusting each other, as the commercial paper market is coyly winking they might be, stuff gets ugly really quickly.

And that’s why I wrote this book, because when the you-know-what hits the fan, it will be the inherently flawed companies that go down. You can beat em’ and you don’t have to join em’, by getting short the The Dirty Dozen.  Lets profit on a big downdraft, not be paralyzed by it.