26 Stocks to Avoid and 3 to Buy Now.

Red Flag #1: Missed Earnings Expectations

Earnings are one of the most important "tells" when analyzing a company's future prospects. Earnings are the pre-eminent indicator of how well the company is progressing toward its goals, and also how well it is managing its bottom line along the way.

When earnings season comes around, investors stay glued to their TVs or the Internet to see how their companies fared for the quarter. And more often than not, if actual and estimated earnings differ by even a penny, the stock gets killed!

That's why most companies like to keep an open line of communication to the analysts who follow them. That way, Wall Street's earnings projections closely mimic the company's, and they are not caught out-of-sync.

But sometimes stuff happens, and every company can have a bad quarter. The past 2 years has definitely shown us that, hasn't it? In fact, most companies–until this most recent quarter–have posted some pretty lousy results, many missing their estimates by a mile.

I've found that you can count on this: If you are in the market for any length of time, some of your holdings will undoubtedly suffer similar fates. But since I tend to take a long-term view of the market, I don't sweat one missed estimate–as long as I can determine that the company is on the mend and no serious fundamental concerns have come to light.

However, my alert button really turns red when a company keeps missing estimates. When that happens, it tells me that the business has some underlying problems. Maybe it's in an incredibly volatile industry, one in which its customers' orders fluctuate wildly. Perhaps it is in the process of restructuring and can't precisely estimate its cost savings. Or maybe they just can't do simple math.

Whatever the case, a history of missed expectations is a huge red flag to me. And with so many good companies out there that aren't missing earnings, why bother with businesses that don't seem to have a good handle on where they are going?

Companies Missing Earnings

Fourth-quarter and first-quarter earnings reports were better than a lot of analysts predicted. Many companies are beginning to see the proverbial light at the end of the tunnel, but others are not so lucky. I reviewed companies that missed earnings for the last four quarters, and I found the following small-cap companies who not only have consistently missed analysts' forecasts for much of this period, but also boast lackluster fundamental and technical parameters.

They wouldn't be the stocks for me, right now, and if you own any of the following companies, you might reconsider your investments:

• TIB Financial Corp. (TIBB)
• Premiere Global Services (PGI)
• IXYS Corp. (IXYS)
• Hardinge (HDNG)
• Collectors Universe (CLCT)
• Thomas Weisel Partners Group (TWPG)

Red Flag #2: Too Much and Expanding Debt

This is one of the simplest ways to judge if a stock is worth your hard-earned money, yet, a thorough review of company debt is often ignored by investors–to their peril. That's too bad, because the analysis of debt is very simple and doesn't require any special investment knowledge.

Instead, you can find out if a company is utilizing its debt properly with just a few basic questions:

• How much debt does the company have?
• Is it growing?
• Are they increasing their earnings by utilizing the debt, or has their expanded debt decreased their income?

First of all, you must recognize that all debt is not bad–contrary to what you may have heard from the talking heads on TV. Without debt, many great businesses would never have gotten off the ground floor.

Think of it like you would your own debt status. Most of us could not purchase a home without taking on a mortgage. Yet, not counting the past couple of years of falling housing prices, our mortgage loans have bought us an increasing asset, one that historically has risen in value approximately 5% per year.

Or, with the average cost of a college education around $20,000, most families need to borrow money to make their children's higher education dreams come true. And, in most cases, the investment in that degree will pay off for decades to come (although it may seem to most parents that day may not come soon enough!).

With corporations, debt serves the same purpose. It allows a company to grab opportunities to make extra money, including expanding their product lines, purchasing other businesses or making investments to update their equipment.

But sometimes, companies–just like individuals–overdo the debt. Their plans are too rosy, and the debt they take on not only does not add to their income but becomes a noose around their neck, often creating a deepening hole of borrowing money to repay borrowed money. Before you know it, they are in big trouble, especially in a weak economy when easy credit disappears. The first thing to go will be their earnings, and then the price of their stock.

Consequently, if the company you are investigating is not managing debt properly, run–don't walk–away from it.

Companies With Debt Problems

It's important to compare your company's debt load, not only against its history, but also its competition. And with the economy still undergoing significant challenges, I think that businesses that are carrying an overload of leverage should be avoided.

Here are a few companies that have significantly high debt ratios for their sectors, and whose other fundamentals and technical factors just don't stack up to the competition right now:

• Alliance Health Care (AIQ)
• Perfumania Holdings (PERF)
• American Community Properties (APO)

Red Flag #3: Bleeding Cash

I'm sure you've heard the saying, "Cash is king." Believe it. I'll use the personal comparison once again. Think of your individual situation. If you have cash, you have the money to 1) buy the things you want or need; 2) pay your debts; or 3) save more of it for future needs.

It's the same for a company. If they consistently generate cash, that puts them in an enviable position. When times get tough (like the last couple of years), they have a cushion to get them through the worst spots.

But cash brings opportunities, too. During economic recessions, companies without adequate cash may not survive. When they go up on the auction block, guess who is ready to buy them? Yep, the businesses with the cash.

Now, you need to know that corporate cash on a balance sheet is similar to the cash you carry in your pockets. Some days you have a few extra bucks, and other days you are looking under the car seat to pay your freeway toll. Most companies do try to keep their cash accounts solidly in the black for their reporting days (at the end of a quarter or year), but know that I don't worry too much about little fluctuations in that account.

What really concerns me is 1) when a company does not have a reasonable amount of cash on hand, but even more importantly, 2) when the operating cash flow account (you can find it on a company's Statement of Cash Flows) is negative and trending downward.

Operating cash flow is simply a tally of the amount of cash a company generates from its primary business. If it makes bicycles, the cash it takes in from selling those bikes is added to operating cash flow. That's what makes it so valuable to look at. Unlike overall earnings, operating cash flow does not include money that comes from investments, real estate, borrowing or anywhere else. It is the money made by the businesses' operations.

Now, you do have to be careful with seasonal or cyclical businesses. For instance, an amusement park operator in Ohio probably won't have positive cash flow during the first quarter of the year, as it's a little too cold to ride roller coasters in January. So, it's smarter to look at operating cash flow over time–not just one quarter.

You don't want to see too many quarters in the red. In that event, I don't waste any more of my time. Chances are it's a stock to avoid.

Companies With Cash Problems

There are many reasons for declining cash flow: rising R&D costs that haven't yet discovered a profitable product; an industry like tech in which obsolescence and continued hefty R&D investment is mandatory; challenging economic periods in which money coming in drops significantly; and just bad business decisions.

Whatever the reason, it's definitely not a good sign, and companies bleeding cash should be avoided like the plague. Here are just a few cash-challenged stocks that I recommend you stay away from right now:

• OccuLogix (TEAR)
• TranS1 (TSON)
• Oculus Innovative Sciences (OCLS)
• Jamba (JMBA)

Red Flag #4: Cutting Dividends

No doubt about it, it's been a trying time for companies that pay dividends–as well as the investors who buy their shares. Luckily, the first quarter of 2010 proved more successful than the first quarter of 2009, when dividend cuts outnumbered increases for the first time since the S&P started tracking them in 1955.

Investors lost some $77 billion in dividends when 367 companies out of the 7,000 that the S&P tracks reduced their payments. That's more than quadruple the 83 companies that cut their dividends in the first quarter of 2008. Not confined to poorly run, small-cap companies, that group included "blue-chips" Bank of America, Citigroup, Pfizer, Alcoa and GE.

The primary reason a company slashes its dividends is that it needs money, and badly. Generally, the business is in the throes of unexpected financial events that will severely affect its earnings–current or future.

And boy, those circumstances fit the bill in 2009, didn't they?

Granted, the current economy and the resulting financial pressure on companies has been unusual, so it's a little more difficult to separate the dividend-cutters who were merely trying to nip short-term problems in the bud from those in which the dividend cut is but it's the first warning of what's to come.

Consequently, it's up to us to figure out why the cut was made and whether it signifies just temporary or long-term challenges for the company.

To do that, you will have to put on your investigator's hat. First, think about the explanation that management gave for the cut–does it make sense?

Next, look at the company's cash position. Does it typically run pretty lean? Has it been decreasing over time to an untenable level?

And finally, review the earnings trend, again, over a period of a few years. Are they trending down, or not growing as much as their industry warrants?

In general, a cut in dividends is not a lightning bolt from the sky. Instead, it's a continuation of bad news that will first show up in cash and earnings.

And as a member of my Buried Treasures Under $10 advisory, you'll always know which stocks are struggling with cash flow and should be avoided. 

Dividend-Cutters to Avoid

It should be no surprise to you that most of the dividend cuts came from financial companies. In fact, in the first month or so of 2009, 35 of the 41 companies who slashed their dividends were financials. And many of those firms continue to face significant challenges, including a need to shore up their capital cushions and repay TARP funds, before they can get back to business as usual.

Therefore, I've taken them off my list of potential stocks to buy. I'll wait to see signs of recovery before I risk my money.

I've been carefully researching financial stocks, as having worked in the industry my whole life and I have a soft spot for them. But I haven't found any just yet that look like pressing buys for us here in Buried Treasures. In fact, my favorite sector–small-cap banks–was hit really hard with dividend cuts in the last year.

I took the poor economy into account when I began my analysis of the sector and tried to not penalize the companies too much for their dividend slashes. But in many cases, the dividend cut was just a symptom of much greater problems, including continued dependence on federal bailout money, a need for further capital infusions and significant (and growing!) loan losses.

After eliminating the banks that I think will speedily recover, here are ones that I would definitely stay away from at this time:

• American River Bankshares (AMRB)
• Cadence Financial Corp. (CADE)
• Cascade Financial Corp. (CASB)
• Central Pacific Financial (CPF)
• FNB United Corp. (FNBN)
• MBT Financial (MBTF)
• Preferred Bank (PFBC)
• United Security Bancshares (UBFO)
• VIST Financial (VIST)

Red Flag #5: Lots of Promise, but No Results

Companies are founded on ideas and hopes, and the reality is that many just don't survive. Unfortunately, there is no magic formula to determine which incubator businesses will succeed and which will fail. When Bill Gates and Paul Allen started Microsoft back in 1975, few could have imagined the heights to which they would eventually climb.

But most companies never make it that far. Many will do well; some will trudge along, barely making ends meet; and others will not survive. According to BankruptcyData.com, in 2008, 136 publicly traded businesses with $1.6 trillion in assets filed for bankruptcy. And in the first quarter of 2009, 44 more bit the dust–more than double the number in first quarter 2008–risking more than $100 million of their assets.

True, the last couple of years have been much worse than normal, and we are not yet out of the woods. We all need to be extra cautious in this economic climate in determining if the companies in which we are invested have what it takes to keep going.

As I said, coming to this conclusion is not black and white. However, there are certain warning signs that will give you a good indication of a company's challenges, as well as its survival potential.

Betting it all on one product. The majority of companies–at inception–do have just one product or service. But, over time, most will expand their offerings, either by design or by accident. That not only brings additional revenue sources into their coffers but helps to diversify their business should one or more product lines experience a setback.

While I tend to veer away from conglomerates that have dozens or more subsidiaries in different sectors, I like to invest in companies that offer some diversification–and investor protection–should one of its business segments suffer temporary adversity.

Companies dependent on outside funding. While most biotechs and pharma companies go into the business hoping to create the next blockbuster drug, very few actually succeed, especially in an uncertain economy. Their R&D efforts require tremendous cash, and during tough economic times, the deep pockets of venture capital funding dry up.

Additionally, it's often a crap shoot, obtaining FDA approval through a series of drug trials that can last years. And in most cases, there's a host of competitors nipping at their heels ready to take advantage of any missteps, such as a failed trial or an FDA order to go back for more R&D.

Now, don't get me wrong. We absolutely need biotech companies, but for most investors, they are just too risky for a strong, long-term portfolio. I recommend that if you just have to have biotech in your holdings, make sure it is a very small portion of your entire funds.

Companies that require continued capital investment. Over the long term, shareholders make spectacular returns by buying businesses that are able to achieve extraordinary returns on capital. This leads to excess capital that the company can use to repurchase shares, pay a dividend to shareholders or reinvest in further growth.

Companies that constantly need to make additional capital investment to keep the business going are the antithesis of this ideal–the main beneficiaries will be employees, management, suppliers and government. Take a look at Coeur d'Alene (CDE) and its long-term performance to substantiate this point. In other words, everyone profits except shareholders.

Biotech Stocks to Avoid

I looked for the biotech companies that were severely challenged–in terms of earnings, debt and cash flow. Additionally, I sought out those stocks whose technical indicators predicted that the bad times may continue for a while.

As I mentioned, I recommend keeping any biotech stocks you own a small portion of your overall portfolio to begin with, but here is a short list of the companies that I would recommend you avoid altogether:

• Repros Therapeutics (RPRX)
• Celera Corporation (CRA)
• CardioNet (BEAT)
• Caraco Pharmaceutical Laboratories (CPD)

Buried Treasure #1: Modern Vessels of the Sea

Thanks to the world's fastest-growing emerging markets, we're seeing a surge in demand for dry-bulk shippers.

In fact, according to a new report by Lloyd's Register – Fairplay Research, this sector will expand by an average of 9.5% through the end of 2013, up from 6.5% annual average growth in the previous five years.

The main catalyst behind this surge is growing demand from China for iron ore and metallurgical coal used to produce steel. According to the report, China produces almost 50% of the world's steel these days, and steel production provides business for nearly half the world's bulk carriers.

As a result, the Baltic Dry Index–which tracks spot rates to ship dry commodities–could rise by 80% thanks to the Chinese government's stimulus programs that are designed to boost factory production.

So it looks like China–once again–will be the main force behind the growth in the dry bulk industry–at least in the near-term. Back in the `80s and `90s, dry bulk shipping barely grew by a couple of percentage points per year. But as China's economy expanded rapidly in the early 2000s, demand for cargo space surged.

And now that the global economic crisis is subsiding, we are beginning to see glimmerings of a return to expansion for the sector. A welcome change, given that two-thirds of the world's products are now transported by sea–iron ore, coal, grain, fertilizers, steels, sugars, and cement.

Because of the increase in demand for dry bulk shipping, spot rates are looking for a healthy increase, as well. So while it will take a little while for the shippers who deploy long-term contracts to participate, participate they will! The move toward long-term contracts has helped stabilize the earnings of shippers significantly, when spot rates have rapidly fluctuated.

But what shipping companies are offering the most bang for our buck right now? Well, the shipping business is dominated by international carriers. So I've directed my sights on an international company that has all the right stuff to ship "the stuff" that will be in demand worldwide.

Paragon Shipping, Inc. (PRGN) ships dry bulk cargoes around the world. The company owns and operates a fleet of seven Panamax dry bulk carriers, three Handymax dry bulk carriers and two Supramax dry bulk carriers with a capacity of approximately 765,137 dwt.

The company's Panamax dry bulk carriers carry predominantly coal and iron ore for energy and steel production as well as grain and a variety of other dry bulk commodities. Their Handymax dry bulk carriers carry iron and steel products, fertilizers, minerals, forest products, ores, bauxite, alumina, cement and other construction materials.

Paragon typically charters its ships for one- to five-year "time charters" in which the revenues are predictable. Thanks to is long-term charter contracts, Paragon held up better than the majority of companies in the Dry Bulk Shippers segment, which–until recently–declined markedly for most carriers.

Overall, I like Paragon's financials, and I think they are the result of the competitive advantages the company enjoys:

• Although it may be young, Paragon's management has more than 60 years of combined experience in the dry bulk carrier industry, including its CEO who has been active in shipping since 1976. In fact, Mr. Bodouroglou founded Allseas Marine, the company's related technical and commercial ship-management company, in 1991.
• Via Allseas Marine, Paragon has built a network of leading customers and brokerage housesworldwide.
• Paragon's fleet of ships is modern and averages just eight years old, considerably younger than the industry's 14-year average age. That helps the company control its insurance and operating expenses, and minimize maintenance downtime.

Ongoing, Paragon has stated that its fleet deployment strategy for new purchases will be "to try to employ these vessels in the medium- and long-term time charter market, while our current fleet is deployed in one- to two-year time charters. We anticipate that this strategy will result in better opportunities and greater transparency of earnings."

Buried Treasure #2:
The Name in Water

You may not realize it, but water infrastructure disruptions are escalating. According to the Water Main Break Clock there are–on average–700 water main breaks in Canada and the U.S. per day. Since January 2000, 2,487,394 water mains have broken, costing $9.9 million to repair.

Nearly one million miles of water pipes in the U.S. still need to be replaced, to the tune of $27 billion. Experts estimate that we are looking at a 5-year funding shortfall of more than $100 billion.

Additionally, the American Society of Civil Engineers awarded a D- to the water infrastructure in this country. And the EPA says that 45% of our pipes will be considered "poor" by 2020. It's an industry begging to be remodeled!

Within the $787 billion stimulus bill passed last spring, $2 billion was allocated for drinking water and $4 billion for wastewater projects. Including provisions in the budget, there's a total of $11.28 billion for water projects. That sounds like a lot of money, and it's a good start, but as you can see it's not nearly enough to repair our outdated systems–much less take care of the coming new growth.

At least 36 states face severe water shortages in the next 5 years. But as the economy continues to recover, I believe we will finally see more attention paid–and money allocated–to this pressing issue, both domestically and worldwide.

When the folks who need it think of water, they think Mueller Water Products (MWA). It's as simple as that. I'm talking about people who run municipalities, the developers who build commercial and residential properties, and the bigwigs in the oil and gas, heating and air conditioning, as well as fire protection industries.

The company manufactures pretty much whatever anyone needs for water infrastructure, flow control and piping component system products for water distribution networks and treatment facilities. Its products include engineered valves, fire hydrants, pipe fittings, water meters and ductile iron pipe. Additionally, Mueller–primarily in Canada–distributes water-related products manufactured by other companies.

More than three-quarters of MWA's revenues are from products that enjoy the number one or number two leadership position in market share. It is number one in fire hydrants, gate valves and ductile iron pipe. The company's products are specified for use in 99 of the top 100 metropolitan areas in the United States.

Its Mueller Co. division is the largest full-line supplier of flow control products such as fire hydrants, valves, metering and related products, machines and tools for tapping, drilling, extracting, installing and stopping-off that are used in distribution systems for municipal potable water and natural gas.

U.S. Pipe is a leading domestic producer of ductile iron pipe and restrained joint products that are used primarily for clean water transmission, for water infrastructure and wastewater customers.

Anvil International is the largest manufacturer–with the most complete line–of pipe fittings, couplings and pipe hangers and supports in the world. Its products are used in fire protection systems, oilfield and HVAC applications, primarily in residential and commercial construction.

According to Mueller, their installed products include approximately three million fire hydrants and approximately 10 million iron gate valves.

Now, the downturn in residential and commercial construction put the brakes on the growth of thousands of companies, including Mueller, but the company continues to post encouraging results, noting that they are paying down their debt.

I love to see this kind of attention paid to the bottom line–especially during a slow recovery when the top line is under tremendous pressure, too.

But lastly–a great sign of better times ahead–both Mueller Co. and U.S. Pipe increased production as a result of rising orders. Mueller is definitely preparing for a new wave of business.

Buried Treasure #3: Bringing Printing into the Digital Age

Now here's a topic that I'm sure many of you have not heard of before: Offset printing. It's the process of transferring (offsetting) from a plate to a rubber blanket, then to the printing surface.

While it's not well known, it's a technology that actually has its origins in 1903, and is still the most reliable printing method today. And while the industry continued to evolve since that time, it had been at a pretty tepid pace.

Then, along came Presstek Inc. (PRST), which has pioneered some of the most profitable (and cleanest) technologies in the printing world. Founded in 1987, Presstek's mission has consistently been to change the way offset printing is produced, with the goals of creating higher-quality printing and faster turnaround for its customers, while enhancing its own profit margins.

And boy, has it succeeded!

• The company has customers spanning the globe, with 66% of its revenues coming from the U.S., 12% from the U.K. and the rest from a range of other countries across Europe, the Americas and Asia. 
• The company has more than 500 patents for image and plate technology.
• It is now recognized as the world's premier provider of environmentally responsible digital imaging (DI), digital offset presses and computer-to-plate (CTP) solutions, primarily for the graphics arts industry. 
• And the company saw its technology adopted by Ryobi, Heidelberg, Xerox, KBA and Kodak.

Presstek is truly one of the pioneers in the industry, chalking up numerous innovations to advance digital offset printing solutions for commercial printing applications, including:

• Inventing the technology incorporated in DI presses and the first DI printer.
• Inventing chemistry-free CTP imaging of printing plates–a big winner in today's environmentally conscious world.
• Significantly streamlining the print production workflow through many innovations.
• Implementing workflows that transition printing from a skill-based craft to a modern manufacturing process.
• Introducing the Presstek 52DI, a highly-automated landscape format DI press with a larger sheet size for higher production environments.

Today, Presstek operates in two primary global markets:

1. Commercial market: targets companies that provide printing and print-related services, such as design, prepress and bindery, on a print-for-pay basis.
2. In-plant market: serves in-house departments that provide copying and printing services to their corporations or organizations.

Until recently, Presstek has concentrated on smaller commercial printers and the in-plant printing market. However, the company has developed new and upcoming products that now allow it to expand into the larger commercial marketplace–a very exciting prospect!

Additionally, the shift in the printing industry to smaller order quantities (shorter runs of 5,000 copies or less), at faster turnarounds and with an increasing use of color, provides opportunities that are right up Presstek's alley–or in this case, their digital imaging offset presses! In fact, Presstek has presses that can accommodate both the small and the more than 20,000 runs needed by its growing list of customers.