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Small Cap Stocks Are Dangerous

The Risk/Reward of the entire Russell 2000 gets our Dangerous Rating. Our recently published Index Benchmark report on the Russell 2000 offers unique insights into the underlying profitability and valuation of all the companies comprised by this index. It also offers benchmarks for (1) investors considering buying ETFs or Index Funds based on the Russell 2000 and for (2) comparing individual stocks to the Russell 2000.
by David Trainer, Founder & CEO
New Constructs
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Stock Pick of the Week: Short Rackspace Hosting Inc (RAX) – Ignore the Takeover Hype

RED FLAGS: 1. Mis­lead­ing Earn­ings: RAX reported a $30mm increase in GAAP earn­ings while our model shows eco­nomic earn­ings declined by $13mm (a dif­fer­ence of $43mm or 7% of rev­enue). 2. Very Dan­ger­ous Val­u­a­tion: Stock price of $25.636 implies RAX must grow its NOPAT at 25% com­pounded annu­ally for 17 years. A 17-year Growth Appre­ci­a­tion Period with a 25% com­pound­ing growth rate is quite a high stan­dard to beat, as per my post on How To Make Money Pick­ing Stocks. 3. Outstanding Stock Option Liability of $205mm or 6.5% of current market value
by David Trainer, Founder & CEO
New Constructs
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Stock Pick of the Week: Sell/Short CB Richard Ellis Group, Inc. (CBG) — Very Dangerous Rating

RED FLAGS: Mis­lead­ing Earn­ings: CBG reported a $1,045mm increase in GAAP earn­ings while our model shows eco­nomic earn­ings declined by $358mm. Very Dan­ger­ous Val­u­a­tion: Stock price of $19.06 implies CBG must grow its NOPAT at 20% com­pounded annu­ally for 15 years. Has any company ever done that, much less a commercial real estate company?
by David Trainer, Founder & CEO
New Constructs
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Rite Aid Corp (RAD) — Dangerous Rating, free report for Ask Matt Readerss

Rite Aid Corp (RAD) gets a Dan­ger­ous Rat­ing because of these RED FLAGs: 1. Very Expen­sive val­u­a­tion: cur­rent stock price implies the com­pany will grow revenues and NOPAT at 6% com­pounded annu­ally for the next 15 years while also more than doubling ROIC from 6.1% to 13.7% within the same time frame. 2. Off Balance-Sheet debt: of $5,502mm or 93% of "Reported" Net Assets 3. Asset-write-offs: $3,417mm or 58% of "Reported" Net Assets
by David Trainer, Founder & CEO
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Drugstore.com Inc (DSCM) — Dangerous Rating, free report for Ask Matt Readers

Drugstore.com (DSCM) gets a Dan­ger­ous Rat­ing because of these RED FLAGs: 1. Very Expen­sive val­u­a­tion: cur­rent stock price implies the com­pany will grow rev­enues at 20% com­pounded annu­ally for the next 15 years while also improv­ing ROIC from –2.3% to 10.9% within the same time frame. 2. Off Balance-Sheet debt: of $15mm or 15% of Net Assets 3. Asset-write-offs: $210mm or 206% of Net Assets
by David Trainer, Founder & CEO
New Constructs
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Stock Pick of the Week: Sell/Short CBS Class B (CBS) Very Dangerous Rating

CBS’s get our Very Dan­ger­ous Rating. There is lots of down­side risk given the Mis­lead­ing Earn­ings and there is lit­tle upside reward given the already-rich expec­ta­tions embed­ded in the stock price. RED FLAGS: 1. Mis­lead­ing Earn­ings: CBS reported a $11,899mm increase in GAAP earn­ings while our model shows eco­nomic earn­ings declined by $548mm. 2. Underfunded Pensions of $2,239mm (20% of market value) 3. Asset-write-offs of $10,559mm in asset write-offs (50% of Net Assets and nearly 100% of the market value) 4. High Valuation: market price implies CBS must grow its revenue at 10% com­pounded annu­ally for 23 years and increase its ROIC from 2.4% to 6% over the same time frame.
by David Trainer, Founder & CEO
New Constructs
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icad Inc (ICAD) — free report for Ask Matt, Dangerous Rating

icad (ICAD) gets a Dan­ger­ous Rat­ing because of these RED FLAGs: 1. Very Expensive valuation: current stock price implies the company will grow revenues at 20% compounded annually for the next 10 years while also improving ROIC from -3.7% to 1.5% within the same time frame. 2. Option Liabilities: of $2.1mm or 3% of the current market value 3. Asset-write-offs: $4.4mm or 7% of Net Assets
by David Trainer, Founder & CEO
New Constructs
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Stock Pick of the Week: Sell/Short Capital One Financial (COF)

The Risk/Reward of invest­ing in Capital One’s stock looks Very Dan­ger­ous to me. There is lots of down­side risk given the Mis­lead­ing Earn­ings and there is lit­tle upside reward given the already-rich expec­ta­tions embed­ded in the stock price. RED FLAGS: 1. Mis­lead­ing Earn­ings: COF reported a $399mm increase in GAAP earn­ings while our model shows eco­nomic earn­ings declined by $1,783mm. 2. The company’s ROIC is in the Bot­tom Quin­tile of all the com­pa­nies we cover. 3. Stock price of $40.69 implies COF must grow its NOPAT at 15% com­pounded annu­ally for 15 years.
by David Trainer, Founder & CEO
New Constructs
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Citigroup — free report for Ask Matt, Dangerous Rating

Dangerous Rating with several RED FLAGS. See my recent post Mayo Is Right about Citi for details on our analysis of the company's loose Deferred Tax accounting and other Red Flags. There are other reasons to run from this stock. RED FLAGS: Over $7bn in off-balance sheet debt $2.2bn in under-funded Pension liabilities Over $10bn in Asset write-offs Very Dangerous valuation (detail follow)
by David Trainer, Founder & CEO
New Constructs
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Mayo Is Right About Citigroup

A large write-down of its deferred tax assets could be devastating for Citi--over 30% of its total book value is comprised of net deferred tax assets. Our detailed analysis of the Notes to the Financial Statements also found these RED FLAGS : 1. Over $7bn in off-balance sheet debt 2. $2.2bn in under-funded Pension liabilities 3. Over $10bn in Asset write-offs
by David Trainer, Founder & CEO
New Constructs
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JDS Uniphase Cp (JDSU) — free report for Ask Matt, Dangerous Rating

RED FLAG: Our analy­sis of the Finan­cial Foot­notes reveals: the com­pany has writ­ten off over $60bn in assets over the last twelve years. That is a big num­ber com­pared to the company’s mar­ket cap of roughly $2.2bn and its net assets of about $1.3bn. This results in economic earnings of -$5,346mm compared to Net Income of -$866mm during the last fiscal year. For details on what causes the dif­fer­ence between Eco­nomic Ver­sus Account­ing Prof­its, see Appen­dix 3 on page 10 of our free report on JDSU.
by David Trainer, Founder & CEO
New Constructs
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NYSE – Why it’s on the Most Dangerous List

There are two primary reasons a stock gets on our Most Dangerous List: 1. Misleading earnings: reported GAAP earnings are positive and rising while economic earnings are negative and declining 2. Expensive valuation: future cash flow expectations embedded in the current price are unusually high especially compared to historical performance. Free copy of our report on NYX is in the Free Archive on www.newconstructs.com. Or just click here: NYX Company Valuation Report.
by David Trainer, Founder & CEO