Warning: Stay Away From This Stock

We often turn to my five rules for tech investing success to see which stocks to buy.

But those same rules will also help you figure out which to avoid.

[ad#Google Adsense 336×280-IA]That’s a critical part of the game.

Because in investing, “job one” is to make sure you live to trade another day.

So a huge part of your long-term success comes down to not losing money in the first place.

I wanted to talk with you about this today because I’m picking up a ton of online chatter claiming that Valeant stock has become a screaming bargain.

And sure, it sounds like a bottom-feeder’s dream come true.

Since its Aug. 5 high, Valeant stock has dropped more than 65%. If it regained just 69% of its previous high, it would double.

But don’t believe the hype.

I ran this stock through the five rules in Your Tech Wealth Blueprint, and what I saw was a deeply troubled company you should stay well away from.

Let me show you why you’ll be glad you avoided this company at all costs…

The Stock That Fell to Earth

Sometimes the best trades are the ones you never make.

That’s certainly true of Valeant Pharmaceuticals International Inc. (NYSE: VRX).

On the surface, Valeant looked like a good bet. After all, you’d be hard-pressed to find a higher flying company.

The Canadian firm used its expertise in skin, stomach, and eye health to garner sales of $8.25 billion last year, more than double the $3.5 billion it earned in 2012.

Not surprisingly, VRX stock shot up to reflect that massive growth.

Until its sudden fall from grace on Aug. 5, the Valeant stock price had soared some 174% in just two years, beating the S&P 500 Index by 634%.

But Valeant may have flown too close to the sun…

Beware of Valeant Stock

To begin with, the company depended on an alliance with Philidor Rx Services LLC for much of its sales. In a practice that departed from industry standards, the “specialty” mail-order pharmacy basically only filled prescriptions with drugs made by Valeant.

And Valeant now faces accusations that it used Philidor to avoid scrutiny over drug prices from health insurers so that it could keep profit margins artificially high.

Let me be clear on something: No one at Valeant or Philidor has been charged with criminal wrongdoing. But this is definitely a messy corporate scandal that raises disturbing questions about Valeant’s business practices.

Now then, I’m aware that many speculators are drawn to just this sort of distressed stock in the hopes that it’s greatly oversold.

So, to help you determine if this is indeed a “special situation” worth considering, if only for the high-risk portion of your portfolio, let’s run Valeant through the five filters of my tech investing system.

Rule No. 1: Great Companies Have Great Operations

You’ll find your best returns with well-run firms with top-notch leaders.

Just on this aspect alone, we’d have to give Valeant a failing grade. It has two black marks against it.

First, CEO Michael Pearson is credited with building Valeant into a growth machine. But his judgment and business practices have come under intense scrutiny.

Second, his company has become an industry pariah. Last month, Valeant disclosed that federal investigators are probing the company’s sales and distribution practices with the Centers for Medicare & Medicaid Services.

These accusations alone call the company’s core operations into question, along with the steadiness and integrity of its leadership.

Rule No. 2: Separate the Signals from the Noise

To create real wealth, you have to ignore not just hype put out by this or that company, but also the noise you hear so often on Wall Street.

In this case, the noise is so loud that it’s hard to get a clear sense of what’s really going on with Valeant. Yes, the company has ended its relationship with Philidor, but we can’t at this time assess the impact that move will have on the company’s growth and bottom line.

Valeant’s defenders and critics are battling it out in the media.

In fact, Warren Buffett’s vice chairman, Charlie Munger, has accused Valeant of being “too aggressive in ignoring moral considerations in the way it did business.”

Public displays of this kind are never good for investors trying to sort out fact from fiction.

So, until we get a report from an independent third party about Valeant’s business practices – that is, until we get some good clear signals – we can’t determine just how much value is there.

Rule No. 3: Ride the Unstoppable Trends

Look for stocks in red-hot sectors. As those stocks ride the trend higher, they’ll offer you your best chance to reap market-beating gains.

There’s no question that Valeant is in a high-growth sector. The biopharmaceutical industry has a huge pipeline of new drugs with high profit margins. And because of their patents, many companies in this industry are protected from competition.

And that’s not all.

Obamacare is adding millions of people to insurance rolls, boosting drug demand. And the presence of 76.5 million aging baby boomers almost guarantees high sector growth for years to come.

So, we’d have to say Valeant clears the bar for that rule. So the question becomes: Does the sector’s huge potential make up for Valeant’s other deficiencies?

I do not believe it does.

Rule No. 4: Focus on Growth

Companies with the strongest growth rates almost always offer the highest stock returns.

At first glance, Valeant appears to have this rule locked up. Over the past three years, it has grown its sales by an average of 50%, which means that sales double roughly every 18 months.

But remember, we’re basing that projection on past performance that made Valeant the darling of Wall Street. We simply can’t predict how well it will do in the future now that it has ended its alliance with Philidor and is looking for new, untried sales channels.

And as tech investors, we always want to be able to predict future growth as accurately as possible.

Rule No. 5: Target Stocks That Can Double Your Money

This is where we look at Valeant’s earnings growth and see how long it will take the firm to double profits. By doing that, we can figure out how long on average it should take for the stock to roughly double in value.

Once again, the serious uncertainty surrounding Valeant makes it difficult – if not impossible – to project future earnings.

Now, turnaround investors might be tempted to take a run at the stock because it’s 65.5% below its record high. If it regained just 69% of that price, we’d have profits of more than 100%.

However, after considering all the factors working against the stock, I see that scenario as pure speculation.

Stuck in “No Man’s Land”

The company has not announced anything approaching a true turnaround plan, and we don’t even know how long the current CEO will be on board.

What my five rules tell us is that Valeant doesn’t fit into any single, clear profitable investing category.

It’s neither a solid foundational play, nor a true growth stock.

And as you’ve just seen, at this juncture, it’s a poor candidate as a special-situation play.

So, until a clearer story about Valeant emerges, and we get our hands around some good, hard numbers, I would avoid this stock.

— Michael A. Robinson

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Source: Money Morning