In my most recent contributions to The Rich Investor, I analyzed whether overhyped, overpriced initial public offerings (IPO) signal a market top. Stocks like Lyft (Nasdaq: LYFT) and Uber (NYSE: UBER) made pre-IPO shareholders rich and left everyone else holding the bag.
I’ve also looked at Tesla (Nasdaq: TSLA), explaining why it’s the worst-ranked stock in my proprietary Forensic Accounting Stock Tracker (FAST) system. TSLA is under a lot of pressure.
That’s the kind of exposure we’re well-aware of. It’s time to talk about a bigger danger lurking in your portfolio…
It’s not an overhyped, glossy-growth story. It’s an old, stodgy company founded almost 180 years ago. And you probably own it; it’s in nearly every portfolio because it’s a key component of the big indexes.
But, first, a brief history lesson…
When the next bear market strikes, two types of companies will face enormous pressure. These stocks are set to fall much more than the overall market. The impact of the next bear market will be devastating.
That’s because this bull market has been built on cheap, easy credit. Other bull market bubbles pale in comparison. So, the first type of company that’ll feel particularly acute pressure is one that made a bunch of acquisitions to mask slowing growth.
Without getting into the weeds of acquisition accounting, companies that make a bunch of acquisitions artificially boost their cash flow. That means they must make bigger and bigger purchases to “move the needle” on revenue and earnings. It’s not a virtuous cycle.
When access to credit is cut off, they’re exposed. It becomes tougher to make a new purchase. Everyone is scared to death of the market anyway.
That’s when everyone sees the emperor has no clothes.
As for the stock price? Down… big…
The second type of company is one that liberally extended credit to customers to boost sales and cover up subpar growth.
These companies implode too… big time… and so do their stock prices.
I’ve seen it happen in the last two short-selling hedge funds I managed in the last two bear markets. It’s breathtaking.
I’ve learned a lot from those experiences. And I’m using that knowledge to make smart and “FAST” moves when and where other market participants just aren’t looking…
Let’s Name Names…
Near the top of the list of my concerns here is Deere & Company (NYSE: DE).
John Deere has been making agricultural equipment for 182 years. That’s almost two centuries. A bear market is unlikely to wipe it out – unless it’s a 100-year storm.
That said, Deere is as vulnerable as it’s ever been. That’s because its earnings quality scores have deteriorated sharply in recent periods.
What’s more troubling is that current management heavily financed sales in recent years. Financing can be dangerous because aggressive terms may cause a customer to buy something today that they otherwise would’ve waited until a later date to purchase.
This kind of revenue is “pulled forward” – another way to say it is it’s “stolen” from the future.
Now, you must find a new customer to fill that “stolen” revenue. Of course, if business is booming, you wouldn’t have to offer favorable terms in the first place.
The problem comes into much sharper focus during bear markets. That’s because credit typically freezes up. In addition, if the economy tanks, what are they going to do, repossess a tractor in the middle of the night?!
It’s not worth much. I’d leave the keys in the ignition and a light on for you…
Here’s why I’m on alert right now: Deere just reported a clunker of a quarter.
Management reduced guidance. There’s pressure from China-related trade issues, and this could be just the beginning.
DE more than doubled as the aggressive financing strategy was taking shape. Now, its price is beginning to reflect the fact that those “greener” pastures are showing some bigger and bigger brown patches…
How Low Could It Go?
In the last bear market, DE fell about 65%. With heavy financing of sales this time around, I fear the next rough patch could be far worse.
It’s not a safe stock.
What’s more, the yield is lower than what’d earn on a typical certificate of deposit. And the CD is safer.
Why take a risk of a huge blow up with a company that juiced sales in prior periods?
If that’s the decision you’re down to, let your money sleep softly and earn a higher rate of return…