Stocks to avoid

January 25, 2002: 2:02 p.m. ET

Since discretion is the better part of valor, here are eight stocks that investors should be skeptical of.
By Staff Writer Paul R. La Monica

NEW YORK (CNN/Money) - The bulls are back. Or so it seems. Although stocks have endured a rough January due to earnings woes, the major market indices are still well above the lows they hit on Sept. 21. And that's all the more reason why investors need to be more careful than ever.

So how should investors go about trying to find stocks to shun these days? Considering the big gains the market has experienced in the past four months, it might make sense to take a contrarian view toward stocks that are universally loved by Wall Street. It is also worthwhile to check what short sellers, investors who think a stock will go down, are betting against. Finally, investors should not forget the lessons learned in this bear market --� stocks with exorbitant valuations and without the fundamentals to support them, eventually fall.

Big doesn't mean safe
When everybody loves a stock -- indicated by numerous "strong buy" ratings from Wall Street and unwavering love by big institutions, contrarians get scared. First, the contrarians say, the herd is usually wrong. And second, even if the companies are great, if everybody has already bought the stock, what's going to drive it higher.

On that basis, Bernie Schaeffer, CEO of technical analysis firm Schaeffer Investment Research, says investors might want to stay away from companies like General Electric, Microsoft and Citigroup.

These three mighty companies are owned by so many mutual funds and are recommended by nearly all the analysts that follow them. Schaeffer argues that any negative news about these companies or the economy in general could trigger "wholesale dumping".

"Institutions are the thundering herd. That's where the real vulnerability comes in. Money is already put on the line with these stocks as opposed to being on the sidelines waiting to come back in," Schaeffer says.�

To that end, 17 of the 20 analysts following Citigroup (C: down $0.28 to $49.62, Research, Estimates) have it rated at least a buy (with 15 strong buys) and institutions own 64 percent of the float, or available shares, according to Vickers Stock Research. Institutions own 58 percent of Microsoft's shares and 22 of the 28 Microsoft (MSFT: down $0.80 to $63.80, Research, Estimates) analysts have buy ratings on the stock. And GE (GE: up $0.71 to $38.26, Research, Estimates)? Everybody loves it. All 16 analysts following the stock have it rated at least a buy and institutions own 52 percent of the float.

Schaeffer stresses that he sees no major fundamental problems with these companies (i.e. none of them are Enrons waiting to happen) but that the stocks are not immune to continued softness in the economy, especially given the fact that they've bounced back sharply from their Sept. 21 lows. Citigroup has gained 37.2 percent, Microsoft is up 30.1 percent and GE has increased 20 percent.

Not wild about wireless
Mainstream Wall Street tends to wear rose-colored glasses -- optimism drives commissions and stimulates investment-banking business. But short-sellers make their money by looking for problems. And the latest bunch of stocks they've zeroed in on is in the wireless sector.

In particular, they've made big bets on two carriers, Sprint PCS and Nextel: 30 percent of Sprint PCS's (PCS: up $0.28 to $17.55, Research, Estimates) available shares were being held short as of mid-January while 11.2 percent of Nextel's shares were being held short. And short interest on AT&T Wireless (AWE: up $0.04 to $11.64, Research, Estimates) has ballooned 82.6 percent since mid-November.

Lehman Brothers downgraded the wireless sector last week, citing concerns about the overall economy and even slapped a rare "sell" rating on Nextel (NXTL: down $0.15 to $8.36, Research, Estimates).

Even though many wireless stocks have already taken a pummeling this year, the news doesn't seem to be getting much better for the group.

Cingular Wireless, a joint venture of BellSouth and SBC Communications, reported lower-than-expected subscriber growth in the fourth quarter on Tuesday. Sprint PCS and Verizon Wireless -- which is scheduled to go public sometime this spring -- also reported lower levels of subscriber growth than what Wall Street was anticipating.

And as the companies prepare to transition to the much ballyhooed 3G wireless networks, the carriers, most of which are unprofitable, will be forced to burn more cash. "The carriers will be in a capital expenditures trap. As new generations of service become available, they either need to spend money on networks or lose customers," says Marc Van Tricht, portfolio manager with hedge fund firm Troy Asset Management.

Satellite radio stocks are in the stratosphere
At the same time that there are concerns about slowing growth in the wireless sector, another wireless technology of sorts, the nascent satellite radio business, has received a lot of positive buzz.

The two publicly traded satellite radio stocks have rocketed into space, so to speak, since one of the companies, XM Satellite, launched its service on Nov. 12.

The other company, Sirius Satellite, is set to rollout its service in four markets on Valentine's Day and plans to have the service available nationwide by the third quarter of this year. XM's stock has soared 116.7 percent while shares of Sirius have shot up 146.1percent. As a result, the valuations are extremely rich.

In 2001, XM Satellite (XMSR: down $0.62 to $14.33, Research, Estimates) �lost $307.5 million, or $5.13 a share. Analysts are expecting the company to lose $5.80 a share in 2002. So to value the company, it's more appropriate to look at a price to sales ratio -- remember how they were all the rage during the Internet craze?

Analysts predict that XM Satellite will generate $29 million in sales this year. To be sure, that's a huge increase from the company's revenue of just $530,000 last year. But is it enough to justify a market value of $1.1 billion? XM Satellite is trading at 37.6 times 2002 estimated revenues. Salomon Smith Barney analyst Armand Musey downgraded XM Satellite on valuation concerns earlier this month.

Sirius is even more expensive. Analysts estimate that Sirius (SIRI: up $0.08 to $6.97, Research, Estimates) will lose $6.69 a share in 2002 compared to an estimate of a $5.45 per share loss last year. The company is expected to report revenues of $6.8 million in 2002. So with a market valuation of $506 million, Sirius is trading at 74.4 times 2002 revenue estimates.

Satellite radio may eventually (pardon the pun) take off. But remember how everybody on Wall Street raved about how Internet retailing would change the way people shop back in 1998? Even though the Internet has had an impact, you'd be hard pressed to find an e-commerce stock that is trading higher now than it was during the bubble.