Corporate Profits ‘Dangerously’ High; Labor to Grab Bigger Share: Research Affiliates

Profits over the past couple of decades have inflated to bubble-like record highs, and investors should expect them to decelerate or even decline over the next couple of decades.

That gloomy long-term forecast comes from Research Affiliates’ Chris Brightman in the Rob Arnott-led firm’s recent newsletter, but the profit warning comes with an unusual political twist:

Much of Brightman’s analysis emphasizes that today’s high level of corporate profits violates people’s sense of social fairness, accounts for rising populism and all but assures that “corporations’ labor, interest and tax expenses [will] rise faster than sales over the next couple of decades” while profits decline.

The profits bubble discussion comes at a time when the stock market hovers near its all-time high after a long bull run, leading many commentators to think a correction is overdue, while some bulls, like Wharton professor Jeremy Siegel, argue that corporate earnings fully justify today’s stock market valuations.

But what gives Siegel reason to celebrate is cause for deep concern on Brightman’s part. Profits, he warns, are “dangerously” elevated, with S&P 500 real earnings per share far above trend, profit margins at or near record levels and profits as a percentage of GDP and relative to labor income at or near all-time highs.

Capital’s share of income relative to wage earners seems socially unsustainable, he says, predicting that “social and political forces, if not economic developments, will cause it — sooner or later — to revert to a more usual level.”

Brightman, head of investment management for the Newport Beach, Calif.-based indexing firm Research Affilliates, warns that investment professionals should beware the human tendency to uncritically assume that the future will accord with the conditions they have known in their careers.

While “a multi-decade period of zero or negative growth in real earnings per share” needed to reduce corporate profits’ share of GDP may seem preposterous to many, history is replete with examples of sustained profit weakness, he says—the 1970s and 1980s being the most recent.

Brightman points out that the most recent profit bubble to end badly, in 2007, may now be exceeded by 2013 in real earnings per share (EPS) terms, and our current profits boom may now be the second highest in history.

The record holder, in 1916, was followed by a 39-year lull till the next profits peak in 1955, and Brightman points out that two world wars and a Great Depression came in the intervening years.

Brightman traces the current profits explosion to the effect of globalization that started in the 1990s, when quite suddenly China, India, Russia, Eastern Europe, South America and Southeast Asia added 3 billion people to the decades-long stasis during which North America, Europe and a few other countries lived amid economic and technological plenty.

That “seismic shift” quadrupled the advanced economy’s labor force, thus dramatically lowering global poverty while at the same time causing wage stagnation in the old advanced economies — all while bolstering corporate profits to near record levels.

Brightman argues that “corporate capture of government policy” has greatly facilitated globalization and its accompanying profits inflation.

“Rent seeking may be more extreme within our very own financial industry than in any other,” he says, citing the Troubled Asset Relief Program and quantitative easing as prime examples of government policy that has benefited corporate interests.

“For several decades, under governments led by both parties, the close nexus between Wall Street and Washington has facilitated an economic policy that favors politically savvy corporations and too-big-to-fail megabanks,” he writes, noting the “sheer coincidence” between government policy and the Street’s large campaign contributions.

The investment industry exec takes pains to state his appreciation of “business success” and abhorrence of “government meddling in the economy,” but in a rhetorical style not usually found in investment letters adds:

“Because globalization and corporatist economic policies seem to have unfairly tilted the scales against lower skilled workers in developed countries, we sympathize with the growing political pressure to subsidize the creation of low-skill jobs, to  improve the skills and wages of the less proficient, and provide a living wage to the working poor.”

The Research Affiliates head of investment management foresees a decades-long profits bust, emphasizing the growing role of political change in economic policy:

“We cannot predict the quarter or year when profits will peak," he says. "We can predict the catalyst. The share of corporate profits is a political choice.”

GuruFocus Reports Seven Dividend Growers of the Week

Best Medical Stocks To Watch Right Now

During the past week, GuruFocus recognized seven companies as dividend growers. In order to be qualified for this list, the company had to:

Have a dividend of greater than 3%. Have a strong history of stable and increasing dividends. Maintain Guru ownership Have a market cap of greater than $10 billion.

The following seven companies come from various industries and sectors of the market, but they all fit the necessary criteria needed to qualify them as dividend growers.

A comparison of the companies' historical dividend growth:

Ventas Inc (VTR)

On Feb. 14, Ventas declared a dividend of $0.725 per share, representing 4.50% dividend yield for the company. This dividend is payable on March 28 to shareholders of the record at the close of business on March 7, 2014.

The company's historical dividend growth is as follows:

- 10-year: 9.10%

- 5-year: 5.10%

- 3-year: 6.60%

Ventas is a REIT with a portfolio of seniors' housing and healthcare properties in the U.S. and Canada. The company currently operates through three reportable business segments: triple-net leased properties, senior living operations and MOB operations.

Ventas' historical revenue and net income:

The company reported its fourth quarter and year-end results last week which highlighted:

- Year-end FFO of $4.14 per diluted share, up 9% from last year.

- 2013 total normalized FFO topped $1.2 billion, an increase of 11%.

- Fourth quarter net income of $108.4 million, or $0.37 per share.

- Fourth quarter normalized FFO up 7% to $313.6 million.

As of the close of the fourth quarter there were seven gurus that held a position in Ventas. Check out their holdings here.

The analysis on Ventas reports that the company has issued $2.9 billion of debt over the past three years, its dividend yield is close to a 3-year high and its P/S and P/B ratios are trading at near historic lows.

The Peter Lynch Chart suggests that the company is currently overvalued:

Advanced Info Service Public Company Limited (AVIFY)

On Feb. 13, Advanced Info Service Public Company declared a dividend of $0.140 per share, representing 4.50% dividend yield for the company. This dividend is payable on May 2, to shareholders of the record at the close of business on Mar. 31, 2014.

The company's historical dividend growth is as follows:

- 10-year: 0%

- 5-year: 16.60%

- 3-year: 40.50%

Advanced Info Service Public Company is Thailand's largest GSM mobile phone operator with 35 million customers as of March 2013. The company is controlled by the Intouch PLC, which is headed by Temasek Holdings, a Singapore government owned agency.

Advanced Info Service's historical revenue and earnings growth:

The analysis on AVIFY reports that the company's operating margin is expanding, its dividend yield is close to a 2-year high and its P/E and P/S ratios are trading at historical lows.

The Peter Lynch Chart suggests that the company is currently overvalued:

Advanced Info Service has a market cap of $19.92 billion. Its shares are currently trading at around $6.70 with a P/E ratio of 17.80, a P/S ratio of 4.50 and a P/B ratio of 10.80. The company had an annual average earnings growth of 8.40% over the past five years.

Commonwealth Bank of Australia (CMWAY)

On Feb. 13 Commonwealth Bank of Australia declared a dividend of $1.632 per share, representing 5.10% dividend yield for the company. This dividend is payable on April 14 to shareholders of the record at the close of business on Feb. 24, 2014.

The company's historical dividend growth is as follows:

- 10-year: 8.10%

- 5-year: 9.80%

- 3-year: 15.40%

Commonwealth Bank of Australia is Australia's largest retail bank and one of the "Big Four." It also operates in New Zealand and Asia. Its core business is the provision of retail, business and institutional banking services. It is also a major fund manager and has increasing market shares in general and life insurance.

Bank of Australia's historical revenue and earnings growth:

The analysis on Commonwealth Bank reports that the price is nearing a 10-year high of $73.82, the company has enough cash to cover all of its debt, its operating margin is expanding and its revenue has shown predictable revenue and earnings growth.

The company recently released its half year results which reported:

- Statuatory net profit after tax was $4,207 million, representing a 16% increase.

- Declared an interim dividend of $1.83 per share, up 12% from last year.

- Cash on hand was $4,268 million, up 14% from last year.

- Cash return on equity of 18.7%

The Peter Lynch Chart suggests that the company is currently overvalued:

Commonwealth Bank of Australia has a market cap of $111.59 billion. Its shares are currently trading at around $69.23 with a P/E ratio of 16.30, a P/S ratio of 5.10 and a P/B ratio of 2.80.

British Sky Broadcasting Group PLC (BSYBY)

On Feb. 12, British Sky Broadcasting Group declared a dividend of $0.783 per share, representing 3.10% dividend yield for the company. This dividend is payable on April 29 to shareholders of the record at the close of business on March 28, 2014.

The company's historical dividend growth is as follows:

- 10.year: 22.10%

- 5-year: 12.80%

- 3-year: 14.80%

British Sky Broadcasting Group PLC is a television provider in the UK and Ireland and home communications services in the UK. Sky retails pay TV services to residential customers in SD, HD and 3D via satellite, on demand with anytime and on the move with Sky Go.

British Sky Broadcasting's historical revenue and net income:

The analysis on British Sky Broadcasting Group reports that the company has shown predictable revenue and earnings growth, its operating margin is expanding and its price is near a 10-year high.

There were no gurus holding a position in BSYBY as of the close of the fourth quarter.

The Peter Lynch Chart suggests that the company is currently overvalued:

British Sky Broadcasting Group has a market cap of $24.34 billion. Its shares were trading at around $61.80 with a P/E ratio of 16.20, a P/S ratio of 2.00 and a P/B ratio of 14.20. The company had an annual average earnings growth of 11.80% over the past ten years.

GuruFocus rated British Sky Broadcasting the business predictability rank of 4-star.

Reynolds American (RAI)

On Feb. 11, Reynolds American declared a dividend of $0.670 per share, representing 5.20% dividend yield for the company. This dividend is payable on April 1 to shareholders of the record at the close of business on March 10, 2014.

The company's historical dividend growth is as follows:

- 10.year: 10.80%

- 5-year: 10.10%

- 3-year: 10.50%

Reynolds American, through its subsidiaries, manufactures cigarettes and other tobacco products in the United States. The Company's reportable operating segments are RJR Tobacco, American Snuff and Santa Fe.

Reynolds' historical revenue and earnings growth:

The analysis on Reynolds reports that the company's operating margin is expanding, its dividend yield is near a 5-year low and its price, P/B ratio and P/S ratio are all sitting near 10-year highs.

The company announced that its most recent dividend is the 39th consecutive quarterly cash dividend. It also reports that RAI's policy is to return about 80% of the company's current-year net income to the shareholders in the form of dividends.

The Peter Lynch Chart suggests that the company is currently overvalued:

Reynolds American currently has a market cap of $25.67 billion. Its shares are trading at around $47.81 with a P/E ratio of 15.30, a P/S ratio of 3.20 and a P/B ratio of 5.00. The company had an annual average earnings growth of 7.70% over the past five years.

Clorox Company (CLX)

On Feb. 11, Clorox Company declared a dividend of $0.710 per share, representing 3.20% dividend yield for the company. This dividend is payable on May 9, to shareholders of the record at the close of business on March 10, 2014.

The company's historical dividend growth is as follows:

- 10.year: 11.70%

- 5-year: 8.80%

- 3-year: 8.60%

The company is a manufacturer and marketer of consumer and professional products. It sells its products through mass merchandisers, grocery stores, other retail outlets, distributors and medical supply providers.

Clorox's historical revenue and net income:

The analysis on Clorox reports that the company's price has been in decline over the past year, its dividend yield is near a 5-year low, its price is near a 10-year high and its P/E and P/S ratios are near historical highs.

The company recently reported its second quarter 2014 results which reported:

- $0.88 diluted EPS, a decrease of 5%.

- 1% volume increase.

- 0.4% sales increase from last year's second quarter.

- Earnings from continuing operations of $116 million, compared to $123 million last year.

The Peter Lynch Chart suggests that the company is currently overvalued:

Clorox Company has a market cap of $11.34 billion. Its shares are currently trading at around $87.29 with a P/E ratio of 20.60, a P/S ratio of 2.10 and a P/B ratio of 72.70. The company had an annual average earnings growth of 5.80% over the past ten years.

Thomson Reuters (TRI)

On Feb. 11, Thomson Reuters declared a dividend of $0.330 per share, representing 3.80% dividend yield for the company. This dividend is payable on March 17 to shareholders of the record at the close of business on Feb. 24, 2014.

The company's historical dividend growth is as follows:

- 10.year: 6.60%

- 5-year: 4.00%

- 3-year: 3.90%

Thomson Reuters is the world's leading source of intelligent info for professionals as well as businesses. The company creates technology that will deliver crucial information to decision makers in the financial and risk, legal, tax and accounting, intellectual property and science and media markets through the use of the world's most trusted news organization.

Thomson Reuters' historical revenue and net income:

The analysis on Thomson Reuters warns that the company's revenue has been in decline over the past year, its dividend yield is near a 2-year low and its price is near a 5-year high.

The company's recently reported full-year and fourth quarter 2013 results highlighted:

- Revenue grew 2% for the year and 1% for the quarter

- EBITDA was down 7% for the year and 32% for the quarter due to a $260 million charge.

- Full year adjusted EPS was $1.54, compared to $1.89 last year.

- EPS was $1.83 for the full year and $0.49 for the quarter.

- Approved dividend increase, represents 21st consecutive annual increase.

The Peter Lynch Chart suggests that the company is currently overvalued:

Thomson Reuters has a market cap of $28.32 billion. Its shares are currently trading at around $34.53 with a P/E ratio of 221.20, a P/S ratio of 2.20 and a P/B ratio of 1.80.

To view a complete list of high yielding dividend stocks found among the gurus' portfolios, click here.

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Whole Foods Market: Has the Long-Term Story Changed?

Whole Foods Market  (NASDAQ: WFM  )  has entered 2014 with much of its typical momentum, yet its forward guidance is fraught with uncertainty. During last week's conference call with analysts, management tried to explain its ambivalence regarding the company's revenue prospects. On one hand, the outlook has never been better, as Whole Foods has a record 107 stores in its development pipeline.

And yet co-CEO John Mackey was frank when asked about the recent trend of comparable-store sales growth. Mackey communicated that comparables have declined because of a number of factors, implying that there is no single point of execution available for a quick fix. While Whole Foods reported a brisk 5.4% comparable-store sales increase for the quarter, this mark falls below the baseline of roughly 7%, which the company has come to think of as a long-term benchmark. Management cited the inclement weather, which has plagued the country this winter, while acknowledging that competitive pressures may also be hindering sales increases. It also offered that some short-term cannibalization is likely occurring in urban markets such as Boston, where Whole Foods has opened multiple locations in close proximity. 

As a tactic to shore up revenue growth, it's possible that we may see Whole Foods shift its emphasis somewhat in the near term to its new store pipeline. Accelerating stores in development may be a relatively painless way to ensure that the company's long-term growth story remains intact.

Below is a table of Whole Foods' store count at the end of the first quarter during each of the last four years, as well as the number of stores in the company's development pipeline. Whole Foods counts a store as part of its development pipeline when it has signed a building lease (or ground lease when the company will build its own structure). 

Source: Company SEC filings.

It took Whole Foods 30 years to reach the 289-store mark, in quarter one of 2010. But in the last four years, the company has added nearly a third more stores. Both the growth rate of new stores under development and growth rate of total stores have picked up aggressively over this period.

The development pipeline is also growing in relation to existing stores, as can be seen in the table. In 2010, the pipeline of stores was equal to 17.6% of the company's total base. In 2014, the pipeline relative to total stores now is equal to 28.6% of operating locations. A larger pipeline relative to existing stores gives management more flexibility when it projects financial performance. Management can look two to four years ahead and either accelerate or diminish the pace of new square footage as it sees fit to meet revenue goals.

Whole Foods North Miami. Source: Ines Hegedus-Garcia under Creative Commons License.

If Whole Foods shifts its emphasis, will this affect profit?
Should Whole Foods choose to speed up the introduction of new retail square footage, it will have to keep a tight rein on costs. The company has excelled in recent years in controlling pre-opening expenses. Five years ago, in fiscal year 2009, Whole Foods spent $3 million in pre-opening expenses, including rent, for each new store. By fiscal year 2013, it had decreased this average expense by nearly 50% to $1.7 million per store. Management will need to continue its high performance regardless of its new store opening pace. Current investments in price throughout the Whole Foods store base (discounting to gain new customers) will leave little room for the development team to err as it handles an ever-increasing number of store openings each year. 

Another metric related to profit that may be affected if new store openings climb is the company's return on invested capital, or ROIC. As I've discussed previously, management may decide to incur a modest amount of debt in 2014. This will become more likely should management choose to shift to a faster store opening schedule. New debt combined with higher fixed asset depreciation numbers (a function of a recent trend toward larger stores) may stall or slightly decrease the company's current ROIC of 13.3%. However, over the long run, the investment in new stores should equalize ROIC and eventually send it higher. 

Whole Foods' potential market keeps expanding
At a current count of 373 stores, Whole Foods keeps finding new opportunities to branch out, in part because its target demographics keep expanding. David Lannon, executive vice president of operations, mentioned on the earnings call the encouraging first week sales of a new store in Jackson, Miss., "a place we never thought we'd have a store 10 years ago." With each passing year, the grocery category of natural and organic foods continues to race ahead and create market opportunity. For Whole Foods, which just expanded its total potential opportunity from 1,000 stores in the U.S. to 1,200 based on a study of metropolitan markets, ramping up on those glistening new locations may be the best course of action.

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On Valentine’s Day, Jana Partners Shows General Motors Some Love

Heading into Valentine’s Day, General Motors (GM) could have been excused for feeling a little sorry for itself. Its earnings were disappointing, its sales even worse and concerns about steep discounts heightened worries that good news was far, far away. And then there was that recall that made the news yesterday.

REUTERS

No wonder then that General Motors’ shares have dropped 13% this year after gaining 42% in 2013.

But this Valentine’s Day, General Motors is being shown some love. My colleague Brendan Conway notes that activist hedge fund Jana Partners upped its position in General Motors to 8 million shares plus warrants at the end of the fourth quarter from 400,000 at the end of the third.

Shares of General Motors have gained 1.5% to $35.72 today at 12:33 p.m., while Ford Motor (F) has risen 0.7% to %15.18, Toyota Motor (TM) has dropped 0.5% to $115.63 and Honda Motor (HMC) has fallen 0.4% to $36.88.

Treasurys rebound from holiday selloff

NEW YORK (MarketWatch) — Treasury prices climbed on Thursday as investors stepped back into the government debt market after the recent selloff, pushing the benchmark 10-year Treasury yield back below 3%.

/quotes/zigman/4868283/delayed 10_YEAR 2.98, -0.05, -1.68% 10-year Treasury yield

The 10-year (10_YEAR)  yield, which falls as prices rise, fell 2.5 basis points to 2.982%, according to Tradeweb. The benchmark yield closed above the 3% threshold last week for the first time since July of 2011.

The 30-year bond (30_YEAR)  yield fell 3 basis points to 3.913%, while the 5-year note (5_YEAR)  yield fell 2 basis points to 1.718%.

However, trading remained thin as market participants were slow to return to their offices after the holidays.

"The move in rates has not been on particularly high volume," said Ira Jersey, interest-rate strategist with Credit Suisse Group AG. "Some people came in, saw [10-year] yields over 3% and saw that there was some decent value."

Thursday saw a number of data releases. The ISM manufacturing index had a reading of 57% in December, down from a two-and-a-half year high of 57.3% in November. Nonetheless, the data beat expectations of MarketWatch-polled economists, who projected a 56.6% reading. Any reading over 50% indicates expansion.

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Another gauge of manufacturing, the U.S. Markit PMI, hit an 11-month high in December.

The number of people applying for unemployment benefits dropped by 2,000 to hit 339,000 last week, though the data are often skewed by the holiday season. Construction spending rose 1% in November.

Treasury yields have been mostly rising in recent sessions, following a decision last month by the Federal Reserve to begin scaling back the pace of its bond-buying stimulus program. That sent Treasurys to their worst annual losses since 2009, and the broader market to its worst losses since 1994, according to Barclays data.

"Sentiment and positioning data suggest that most investors yearn for higher rates while momentum studies also have crossed deeply into oversold territory for most Treasury benchmarks," said Gabriel Mann, market strategist at RBS, in a note.

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Test Drive: Diesel Cherokee not quite grand

Chrysler put a 3-liter Italian diesel into its Ram pickup and created a powerful smoothie.

Chrysler put the same engine, tuned a bit differently, into its Jeep Grand Cherokee and created a reason to buy the gasoline V-6 instead.

Not that the diesel Grand Cherokee is bad. It's actually pretty good. But it is a bit noisier and rougher-running in the Jeep than in the Ram. And it's $4,500 more expensive than a Grand Cherokee with the gasoline V-6.

Jeep says pshaw to that, asserts that people who buy it — about 15% of Grand Cherokee customers — say the refinement of the diesel is quite good.

That 3.6-liter gasoline Pentastar V-6, newly enhanced with eight-speed automatic and dual exhausts, is refined, quiet and surprisingly zippy. That gas V-6 model with rear-wheel drive won the Cars.com/USA TODAY/MotorWeek Midsize SUV Challenge last year.

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So, we'd be inclined to avoid the $4,500 for the diesel option and live happily with the gas V-6.

The price difference would buy you 1,376 gallons of regular at a recent U.S. average price of $3.27.

The gas engine's rated 20 mpg for city/highway mix, so you could go 27,522 miles before spending enough extra on gasoline to match the higher cost of the diesel engine.

Diesel's rated 25 mpg in combined city/highway driving, for comparison. Four-wheel-drive models of either are a mpg lower.

Fuel prices change, so any calculation depends on what you pay for fuel, and whether you drive enough to make the diesel's fuel efficiency pay off, keeping in mind that diesel fuel is higher-price — $3.92 national average, travel outfit AAA calculates.

Jeep sees the diesel buyer as one who'd otherwise take the Hemi gasoline V-8, for its power, not a strict mpg buyer who'd weigh the diesel against the gas V-6.

The diesel premium vs. V-8 is only about half what it is over the gas V-6. And the V-8 mi! leage 16 or 17 in combined city/highway, so the diesel might seem more sensible. Also, if you tow or haul a lot, where the diesel's superior torque is attractive, or if you simply like the feel of all that torque, then have at it. Life's short. Drive what you like.

As for the Grand Cherokee, irrespective of drivetrain, well, Test Drive is a known enthusiast.

When our experts evaluated the Jeep against five other midsize SUVs priced $38,000 or less last year, a common reaction — shared by Test Drive — was that the Grand Cherokee was too classy, too smooth to belong to the same group.

The others were the Ford Edge, Hyundai Santa Fe Sport, Kia Sorento, Nissan Murano, Toyota Venza.

While this mainly is a review of the new diesel, here are some high and low points of the Grand Cherokee in general, diesel or otherwise.

Gearshift is wretched. It's an electronic switch, operated by a lever in the console. It's imprecise and lacks any satisfying feeling of mechanical connectedness.

Some makers are moving toward such shifters to save space and avoid what they see as the fallibility and noise potential of mechanical linkages.

To us, that seems as wrong a square wheels.

The electronics are among the best. Quick and reliable phone paring, easy navigation, sensible menus.

Improved dashboard and instrument panel.

Before the 2014-model updates, many drivers found the steering wheel blocked the speedometer in the band between about 30 and 90 mph. And the info display readouts used too-small type.

Both fixed.

Seats, at least leather-covered versions, look very nice and sit about as well.

But the diesel by itself is slightly disappointing. We didn't manage quite 20 mpg in driving that was heavier on highway miles than on city and suburban use.

The diesel in the Grand Cherokee did not deliver the same luxurious and irresistible power delivery the engine did in the Ram pickup.

Even for diesel fans such as Test Drive, it takes a li! ttle too ! much to overlook the Grand Cherokee diesel's shortcomings and price.

2014 GRAND CHEROKEE

What? New diesel option for the four-door, five-passenger, midsize SUV updated for 2014. Rear-wheel drive (RWD) or four-wheel drive (4x4).

When? Available since October.

Why? Diesels use less fuel, have more pulling power.

Where? Jeep made in Detroit; engine comes from Italy.

How much? Diesel's a $4,500 option on most models. Least-expensive Grand Cherokee with diesel is $41,590 with shipping for Limited RWD. Test model: well-equipped Limited 4x4, $48,785.

What makes it go? 3-liter V-6 diesel rated 240 horsepower at 3,600 rpm, 420 pounds-feet of torque at 2,000 rpm; eight-speed automatic; RWD or choice of two 4x4 systems.

How big? Five inches longer than a Ford Edge, otherwise, similar. Weighs 5,065-5,393 lbs. Tows up to 7,400 lbs.

How thirsty? Rated 22 mpg in the city, 30 highway, 25 combined (RWD), 21/28/24 (4x4). Burns ultra-low-sulfur diesel; tank holds 24.6 gal.

Tester registered 19.4 mpg (5.15 gallons per 100 miles) in Detroit in a mix of city, highway driving.

Overall: Diesel would be a knockout with a little less noise, a little more mpg.

Retailers: Damaged Goods?

I'm a contrarian value investor at heart and I love trolling the bargain bins; my curiosity is more aroused by the stock that plunges 50% than the one that surges 50%, explains Steve Mauzy, editor of Daily Profit.

That said, I troll carefully. Some sectors tend to produce damaged goods that are even too dinged and dented for my liking.

Through experience, I've learned to avoid betting on a turnaround in an airline (most of the major airlines have been bankrupt at least once), a sit-down casual restaurant, a niche software developer. Once dinged and dented, no amount of putty and burnishing restores the luster.

I also generally avoid retail turnarounds. I've been asked a few times for my opinion on J.C. Penney (JCP) and Sears Holdings (SHLD).

I understand a contrarian's interest. J.C. Penney's share price is down 85% in the past two years; Sears' share price is down 55%. Both are iconic retail names whose history can be measured in centuries.

Contrarian interest is further piqued because of celebrity-investor interest. George Soros owns a 6.6% stake in Penney. Sears is run by investor Edward Lampert, who owns 25 million shares—nearly 25% of the retailer's outstanding shares.

I'm still not on board. In 2007, Penney recorded $19.9 billion in revenue. That same year, Sears recorded $53 billion. Over the trailing 12 months, Penney recorded $11.9 billion in revenue; Sears recorded $37.6 billion. Each successive year brings in fewer dollars.

But what about these are iconic names? Fair enough, but, at one time, everyone was familiar with W.T. Grant, Caldor, Woolworth, Foley's, Service Merchandise, and Montgomery Ward.

A recognizable retailing brand simply doesn't ensure a high level of customer loyalty. Should a retailer fail to anticipate consumer trends, or to price competitively, consumers have no qualms about patronizing the competition.

A turnaround is further hindered by plentiful, fierce competition. The retail sector is easy to enter, and many do. Within a five-mile radius of most suburban homes, a consumer will find a plethora of retail outlets to satisfy nearly all her needs.

Plentiful, fierce competition means retailers must continually evolve. Older retailers like Penney and Sears are rarely thought leaders, and hence, always behind the evolutionary curve.

Retailing also allows any investor to easily kick the tires. When I walk into Sears, I see an antiquated retailing concept. When I walk into Sears' subsidiary, K-Mart, I see dilapidation. J.C. Penney, to me, is a poor imitation of Kohl's (KSS).

Time is another obstacle. Even if energetic, progressive managers take the reins, time works against them. Customers are quick to leave, but slow to return. And when customers are quick to leave, vendors are usually quick to demand more immediate payment terms.

Fewer dollars flowing in, and more dollars flowing out, is a forbidding combination. Returning to 2007, Sears generated $1.4 billion in cash flow from operations.

Over the trailing 12 months, Sears' operations generated a negative $694 million. Penney offers a similar cash-burning tale: Operating cash flows were a positive $1.3 billion in 2007, and a negative $1.6 billion over the trailing 12 months.

When a retailer hemorrhages cash, the ensuing bloodbath frequently leads to irreparably damaged goods. In my opinion, J.C. Penney and Sears are irreparably damaged.

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