V.4:6 (217-219): Are junk stocks really dogs? by Bill Dunbar

Are junk stocks really dogs? by Bill Dunbar

Why this article? In spite of what my wife says, I do follow my own advice, at least part of the time. In some of the past issues of Stocks & Commodities I have promoted bottom fishing, not to catch healthy corporations, but those that are in trouble. However, so many are available in that category now that I am having trouble limiting my investments. So I ask myself, how far should I go? I've had good luck with junk stocks in the past, but it could have been just that—luck. Maybe I have been shooting off my big mouth based on experience that's too limited. If I'm so sure that cheap stocks are the way to easy wealth, why don't I take profits in some of my more respectable winners and plow it all into junk?

Well, as an investor with technical inclinations, my thought is to turn to the past. The fundamental approach, if it was ever worth anything, certainly doesn't apply to junks. How can you place a value on a stock with negative earnings and even negative book value? If the corporation can't pay the interest on its loans and the creditors are pounding down the door, threatening involuntary bankruptcy and liquidation, what are the shares worth? Obviously on a fundamental basis, they are worth nothing, and yet the market places a value on them at something above zero. The value is usually based on pure speculation, speculation that something good will happen, that the business climate will change for the better, that a new and better management will take over, or that the corporation will sell off its unprofitable divisions and become robust once more. What basis is there for such fond hopes? At best, nothing except past experience and, at worst, panting, drooling fantasies. Most of us have a tendency to remember the successful recoveries and forget the ones that went under.