2 stocks to 'sell first, ask questions later'

Forget the analyst spin. This kind of bad news usually opens the door to more troubles ahead -- as this pair of companies may be about to find out.

By StreetAuthority Jul 29, 2013 10:15AM
Arrow Down (© Photodisc/SuperStock)By David Sterman

To paraphrase the 17th-century philosopher Thomas Hobbes, the tenure of a corporate executive can be "nasty, brutish and short." Indeed, many CEOs and chief financial officers last just a few years on the job before the board decides that fresh blood is needed.

Most of the time, such a transition appears to be orderly, but when an abrupt change is made, you should almost always move quickly to sell shares. There's a very good chance that you'll be able to buy back shares at a much better price down the road, for reasons I'll explain in a moment.

Scandal in the grocery aisle
After a series of stumbles, including a botched deal to buy Pringles potato crisps and allegations of price-fixing of in the walnut market, Diamond Foods (DMND) abruptly terminated several executives in February 2012. Shares suddenly collapsed by two-thirds from prices seen just a few months earlier, leading some investors to start to bottom-feed this stock in search of value.

Such buying turned out to be premature, as Diamond Foods' problems only deepened from there, and the company repeatedly missed filing deadlines with the Securities and Exchange Commission (SEC).
Yet even though attempting to catch a falling knife like this is unwise, it's still worthwhile to track a broken company's next moves. It took nearly a year for Diamond Foods' new management team to fix the mess, but by early this year, it was increasingly clear that the crisis was passing and improving quarterly results lay ahead. In the past six months, this stock has posted an impressive 60% rebound.

Polycom and RadioShack: Tied at the hip
Last week, executives at Polycom (PLCM) and RadioShack (RSH) left their companies for very different reasons -- but investors should steer clear anyway.

Video- and audio-conferencing equipment maker Polycom asked its CEO Andrew Miller to pack up his desk after the board discovered "irregularities" on his expense reports. At first glance, this should have no bearing on the company's prospects, and indeed, the company paired this bad news with a fairly solid second-quarter report.

Yet the CEO change means that Miller's successor is likely to come aboard, review operations for a few months, and then establish a new (usually lower) set of forward expectations. That's what all new CEOs do. And these folks often replace key company executives with their own trusted lieutenants, creating disruption in the sales force and product development divisions.

The key takeaway: Although shares of Polycom fell roughly 10% on the news of Miller's departure, few positive catalysts exist in the near term, and a new CEO, once in place, may look to lower earnings expectations for the company as major operational changes are made.

The sinking ship
It's hard not to feel for RadioShack CEO Joe Magnacca. He took the reins of the beleaguered electronics retailer in February and is trying to move quickly to reverse a half-decade of missteps made by his predecessors. Yet he doesn't have the luxury of time. RadioShack's balance sheet has been badly depleted, and the company may need some sort of financial lifeline.

The abrupt departure of CFO Dorvin Lively also implies that Magnacca will have to make choices that are unpalatable to investors. Perhaps the company will need to sell a lot of stock to stay afloat. Perhaps it will sell more bonds with very high yields, which would only heighten the company's financial risk. Whatever tough course is chosen, it's up to the CFO to try to calm nervous investors while internally tightening an already tight cost structure. This CFO's departure almost guarantees that more tough times lay ahead.

Risks to consider: As an upside risk, management vacancies sometimes pave the way for a sale of the company, though that is hardly a reason to consider purchasing a stock.

Action to take:
Can Polycom and RadioShack turn things around? Perhaps. The new management team at Diamond Foods has managed to turn the ship around, but it took several quarters before progress appeared. In the interim, shares were left to drift steadily lower. That's why it's wise to "sell on the news" when you hear about executive departures.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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