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When 'Buy What You Know' Doesn't Pay

Scott Rothbort

In October, when I offered my list of the five worst-managed companies in the U.S., I also had considered several other companies for the honor. But I decided to create a separate list (four companies and one sector) with one thing in common: They have great products, but are bad investments.

We've all heard the Peter Lynch mantra: "Buy what you know." Buying what you know, however, doesn't excuse you from properly researching a company. Just because a company makes a fine product doesn't mean it's not managed poorly or heavily dependent on a single product or subject to a host of other maladies that could singe its stock.

My list could be longer, and you may have your own favorites. Also, note that these are bad investments but could be a decent trade from time to time. Here they are:

1. TiVo(TIVO Quote): This is the quintessential great-product, bad-investment company. Six years ago, I told my wife that we had to buy a TiVo, and she had no idea what a TiVo or DVR was back then. Six years later, we can't live without it. In fact, we still have the original box and lifetime subscription that we originally purchased.

You would think that TiVo had a great concept and would be printing money. Not so. By far, TiVo is the best example of how to screw up the concept of giving away razors and making customers pay for the razor blade. Since going public (and now for 31 consecutive quarters), TiVo has posted a loss. The most recent quarter was the same old story: more losses; litigation issues; fiddling with subscription packages; and delays in collaborative agreement. Buy a TiVo but not TIVO.

2. Six Flags(SIX Quote): What can be more fun than a day with the family at the amusement park? Well, maybe a day at the ballpark, but you get my point. You have to be a real misanthrope to hate amusement parks.

Disney(DIS Quote) knows how to build and manage an amusement park. Six Flags, on the other hand, has managed to deliver declining returns to shareholders. In fact, a weekly chart of Six Flags looks like a roller-coaster ride: a big climb, a rapid fall, some ups and downs, and then a return to terra firma. Six Flags has been under new management for several quarters now and, frankly, it has continued the failures of its predecessors.

The company managed to bungle the Great Escape in the Lake George, N.Y., region. The geniuses at Six Flags repaved the Great Escape parking lot this year (it does look good), but initiated a $10-per-car parking fee. There is a Yiddish terms to describe this decision: chutzpah (gall, audacity, nerve). So they spent lots of cash (heavily borrowed), charged to park, and attendance declined. Spend your hard-earned cash for a day at Six Flags, but not for a single share of stock.

3. Vonage(VG Quote): Get rid of land lines, give your local telephone company the Bronx cheer and use the Internet for telephone calls. Voice- over-Internet protocol (VoIP) sounds great, and many people are switching. My sister-in-law has gone VoIP and is satisfied; I haven't switched, but would consider it someday. I've heard pros and cons in the VoIP debate, but I have to say that as a product and technology, it is a great concept.

Vonage seemed to be promoting itself for years. (I call it the longest road show ever.) It was also the most bungled IPO since the Wilt Chamberlain restaurant debacle in the early 1990s. Since the company went public, the stock has gone straight down, and it's not going to be earning money anytime soon. It fact, it could be TiVo-like. Add to that the fact that the IPO left the company with lawsuits and regulatory issues. So what's to like about this company as an investment? If you have or plan to use VoIP, be careful and don't swap your old AT&T (T Quote) stock for Vonage in the process.

4. Krispy Kreme Doughnuts(KKD Quote): If you read Jim Cramer's Confessions of a Street Addict, then you probably know Jim as someone who lived for a Krispy Kreme and a great stock idea. Unfortunately, the company could deliver only the former, not the latter.

Even though the "under new management" sign is hanging in Krispy Kreme's window, you have to wonder whether its business model is or ever was viable. Sales continue to decline. The baking business has always been tough. Dunkin Donuts has been handed from owner to owner for years with relatively little success. Just look at the history of Interstate Bakeries or Tasty Baking (TSTY Quote).

Bring a dozen Krispy Kremes to your next client meeting, but don't sell them on the stock. Nothing beats McDonald's (MCD Quote) when it comes to a food-service investment.

5. Alternative energy stocks: Let's reduce our dependence on fossil fuels and tell OPEC to stick it. It's the thought that counts. This entire asset class gets the great-product, bad-investment nod. We can use light, water, wind, steam or bovine excrement to generate energy for all I care. But even if Earth, Wind and Fire were to sing for us, it is highly unlikely that a stand-alone company is going to make you a dime in the alternative energy sector.

Maybe some big-cap companies like Archer Daniels Midland (ADM Quote) or a utility like FPL Group(FPL Quote) can hide their alternative energy losses under the rest of their profitable portfolios. Occasionally, a Johnny-come-lately alternative energy stock will go public and get investors all lathered up in the first few months of life, only to succumb eventually to traditional valuation techniques. The Pink Sheets and OTC bulletin boards are littered with the carcasses of alternative energy stocks.

Here is a Web site devoted to alternative energy stocks. Go ahead, knock yourself out, and try to find a stand-alone alternative energy investment. Over the long run, these are bad investments. In the meantime, think green, and invest in Exxon Mobil (XOM Quote).