Ways to identify weak companies

Eight years ago, Blockbuster (BBI) stock was around $30.

Today: About 30 cents. So if you have 10 shares, you still have about enough to rent one last video — so long as your broker waives any trading fees.

This is a disaster movie, right next to Titanic on the shelf. But who went down with this ship? Probably not anyone who had walked into a Blockbuster video store recently and taken a good look around. You could smell the doom years ago.

(How were they ever going to compete with Netflix (NFLX) or the Internet? Year after year, my local Blockbuster could never even remember to order plastic bags.)

There’s a message for private investors in there. Never hang on to a stock if you have a bad feeling about the company as a consumer.

Instead of investing in what you know and like, sell what you know and hate. Call this the Turkey Principle: On the stock market, it’s a lot easier to spot a turkey than an eagle. The irony is that most investors waste most of their time hunting for eagles.

Blockbuster isn’t an isolated example. A few days after the video store chain warned it may have to file for bankruptcy, smartphone maker Palm (PALM) announced “disappointing” sales. The shares, which had risen as high as $18 last fall, slumped to $4.

To hear some people tell it, Palm “surprised,” “shocked” or even “stunned” the market with the news.

Really?

This suggests no one on Wall Street had walked into a cellular store recently. Or heard of the iPhone. Or even just looked around on any street, including Wall Street, or in any bar at what smartphones people were using.

You have to wonder just who was bidding up Palm shares last fall. Palm’s days have probably been numbered since Apple (AAPL) announced the iPhone in 2007, if not earlier. The Palm Pre, launched last year, just looked like too little, too late.

Cue the Turkey Principle.

For two decades, many private investors have been trying to get rich by blindly buying shares in their favorite stores, restaurant chains and the companies that make their favorite products. They were following Peter Lynch’s advice to invest where they shopped. Mr. Lynch, the former manager at Fidelity’s Magellan fund, made this notion the cornerstone of his 1989 best seller “One Up on Wall Street.”

During the bull market of the 1990s, investors did OK. But then, everything went up anyway.

In the last decade the results of following this strategy have been mixed — or worse.

People lost their shirts on hot consumer companies like JetBlue (JBLU) and Krispy Kreme Doughnuts (KKD). Those investing in everything from Gap (GPS) to Amazon (AMZN) to Coca-Cola (KO) to Sony (SNE) suffered huge losses, sometimes for years. Even if the stock did, eventually, turn, many had already sold in disgust.

It’s not enough to like a company’s products. If you want to make money betting on a stock, you need to understand a lot more about it — from the valuation to the fundamentals, including the balance sheet and the cash flow.

So when does a consumer have an edge over Wall Street? When it comes to spotting a turkey.

After all, it’s easier for companies to lose money than to make it.

And the professional investors on Wall Street are constantly being snowed by corporate investor relations machines. Companies, analysts and advisors are busy putting the best positive spin on things. Consumers who never hear from the I.R. team, but who walk past the stores every week, may get a clearer view of what’s really going on.

Investors who “sold where they no longer shopped” got out of turkeys from Circuit City to General Motors to Sprint (S) long before Wall Street.

There are ways for ordinary investors to take this a step further, and actively bet against the next Blockbuster, if they want to.

You can buy “put options” on many stocks, for very little money, through any broker. A put option is simply a bet that the stock will fall below a certain price by a certain time: In other words, it offers a leveraged bet on a stock collapsing. If you bet right, a small stake can turn into big profits. If you bet wrong, all you can lose is the (small) stake.

But for most people, just making sure to keep the turkeys out of your portfolio is achievement enough.

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