The Hazards of Low-Priced Stocks

Tickers in this article: BBY F RSH ZNGA

NEW YORK (TheStreet) -- If Zynga didn't prove it last week, nothing will: Low-priced stocks can get you killed.

I allocate a very small portion of my portfolio to low-priced, speculative stocks. Because of this, I can stay calm -- and long -- ZNGA because the 40% on-paper loss really doesn't do much to harm the overall health of my portfolio. Throw in a few more ZNGAs and there's a problem.

That said, if you're going to dive deeper into low-priced names, you need a good guide. There's really nobody better than David Peltier, who runs the TheStreet's Stocks Under $10 premium service. (Sign up for a free trial to get a feel for David's work.)

In any event, I lean toward slapping a personal sell rating on most low-priced stocks. Generally, they're low-priced for a reason. Often, the market, for one reason or another, has mispriced a stock, but don't fool yourself into believing that happens frequently in the sub-$10 underworld.

About a month ago, several readers ripped me for suggesting investors stay away from Ford . Since then, the stock has plummeted nearly 11%, closing this past Friday at $9.00, below that $10 mark.

By most accounts, Ford just has to rise again (it's destiny!), even though it has done nothing but drop or stagnate over the last year and a half. The numbers, particularly Ford's absurdly low forward price-to-earnings ratio, suggest considerable upside.

Viewed from another, more qualitative, perspective you really have to ask yourself where this upside will come from.

First, there's no guarantee that Ford will not lower expectations again, particularly in Europe, which could render forward-looking projections moot. Second, it not only needs Europe to recover; it needs the European public to start buying its cars as part of a recovery. Third, domestic sales represent a bright spot for Ford. Do you really see them getting much better than they are now?

In the auto space, it makes more sense to look at Tesla Motors . Although I'm not head-over-heels bullish on TSLA, it puts out a much less messy blueprint for success than Ford. Tesla sells a limited number of very expensive cars to an affluent, targeted niche market that, to the extent Tesla needs, does not feel economic shocks like folks in lower income categories do.

From a low-priced standpoint, you might ask, "How in the world can you be long ZNGA, but argue against F?" That's a fair question. The answer really does not diverge much from my thoughts on Tesla.

As ugly as things look for Zynga, it has a far less uncertain way forward than Ford does. Of course, Zynga must execute, but all else being equal, Zynga controls a greater share of its destiny than Ford does. In other words, economic and political uncertainty does less to derail a low-priced stock like ZNGA than it does F.

I am more confident that Zynga will be able to successfully migrate away from Facebook and monetize mobile than I am that auto sales will continue to grow in the U.S. (and that Ford will capture a lion's share of them) and that Europe's economy will not continue to have serious problems.

I also like the chances of a short-term bounce for ZNGA. Do not overlook the that the company has minimal debt and $1.6 billion in cash. Unlike a disaster such as Research In Motion , Zynga not only has cash, it has first-mover advantage and a leadership position in social gaming.

Zynga made some mistakes -- there's no question about it. Management might have even knowingly screwed shareholders. That remains to be seen. And there's no doubt, the company absolutely has to stop CEO Mark Pincus from speaking publicly. Frankly, he does a horrendous job at it. All of that said, the market overreacted last week.

The market did not overreact, however, to the unmitigated implosion that is Radio Shack .

What is the way forward at Radio Shack? I usually have a plenty to say. Often too much. I've got nothing here. But I will say this: Within five years, retail outlets, brick-and-mortar and online, that do what Radio Shack does or anything close to it will be, with one or two exceptions, extinct.

Best Buy and a local/regional electronics chain here or there might survive.

Best Buy could get by because it's conducting a CEO search using the same firm that encouraged the bold (and smart) move of bringing Marissa Mayer to Yahoo! . But that CEO has got to be a Silicon Valley type like Mayer (e.g., Stephen Gillett), and the board must allow him or her to go beyond feeble attempts at change such as reduced square footage and cheap knockoffs of the Apple retail concept.

I'm not sure Radio Shack has the culture to do anything remotely close to what I expect Best Buy to do and what Yahoo! did. In fact, there's no life left. It would take a miracle, quite possibly something more extraordinary than what Ford needs, for Radio Shack to subsist, even close to what it is, for much longer.

Don't take a chance on Ford just yet. Never take one on RSH. Consider a speculative bet with ZNGA. But, really, tread carefully with low-priced stocks. Stick with large, dividend-paying growth stocks unless you have a time-tested, well-oiled plan to speculate on beaten-down, sub-$10 stocks.

At the time of publication, the author was long FB and ZNGA.

Tickers in this article: BBY F RSH ZNGA