The "Less Bad" Rally Continues

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Eventually, investors are going to realize that bad is bad no matter how you spin it.

Two weeks ago, I noticed an alarming trend throughout the market: some stocks were rallying higher even though the overall results of their earnings reports were downright terrible. Fast forward to last night, and you'll see the same trend continues to pervade the marketplace.

Below I've highlighted three more offenders to the "less bad" list, and I strongly suggest you trust your instincts and stay away from these potentially dangerous investments.

AK Steel (NYS: AKS)
Alcoa (NYS: AA) pretty much set the stage for continued poor performance from the metals sector two weeks ago, when it reported a fourth-quarter loss and warned that demand in Europe was likely to remain weak for the foreseeable future.

It didn't really surprise me then when AK Steel last night came out with a third-quarter loss of $0.26 on a 9% rise in sales. Believe it or not, these figures both beat Wall Street's consensus expectations. But the real kicker is in what AK Steel CEO James Wainscott had to say about the steel business: "The economic recovery we've been anticipating for several years simply did not fully materialize in 2011, and we endured another round of raw-material price increases." Not only does that not sound encouraging, but AK Steel failed to provide forward guidance because of "uncertainty and volatility" in the U.S. steel market. Despite this, the stock rose yesterday -- D'oh moment No. 1.

RF Micro Devices (NAS: RFMD)
RF Micro's third-quarter report last night was a monumental failure. The company blamed a greater-than-seasonal decline in sales to cellular handset manufacturers in China as the primary reason it missed on EPS in the third-quarter, and why it was forecasting just $185 million in revenue and an earnings range of breakeven up to a loss of $0.02 in the fourth quarter. Wall Street had pegged RF Micro for sales of $204 million and a profit of $0.03. But just like the infomercials tell you, "Wait ... there's more!"

Not only did sales decline sequentially by 8%, but gross margin absolutely fell off a cliff by 890 basis points from the second quarter and 850 basis points from the year-ago period. It's not as if RF Micro's costs have risen (they actually dropped from the year-ago period), but its business is literally shrinking in a seemingly exponential manner. And you guessed it, the stock rose in after hours last night -- D'oh moment No. 2.

Clearwire (NAS: CLWR)
Clearwire likely roped in more buying interest this morning when it released preliminary fourth quarter guidance highlighted by a more than doubling in sales and an actual EBITDA profit of $46.5 million. The company, which more or less relies on Sprint Nextel's (NYS: S) $1.6 billion lifeline to remain solvent, also expects to add 900,000 subscribers during the quarter. I know ... it sounds bullish, but recall that EBITDA does not always translate into bottom line profits.

Just so you don't get confused, let me also highlight some other key points from yesterday. Clearwire's churn rate -- the amount of subscribers it loses -- rocketed higher to 2.9% from the 1.5% it reported last quarter. In addition, the company priced $300 million more in debt at (get this) 14.75%, which is due in 2016. How do you know your company is a risky bet? Answer: When you have to offer 14.75% on your debt before anyone will bite! Clearwire finished yesterday up nearly 3% -- D'oh moment No. 3.

"D'Oh" does not equal "dough"
If Homer Simpson was here, he'd gladly remind you that "D'oh" does not equal "dough!" I've said it before and I'll say it again: Buying into less bad results is not an investment strategy! These three companies posted what I would deem to be pretty bad results and investors have blindly rewarded them. Don't be surprised if shareholders get a rude awakening one of these days, and for your own sake, make sure you're buying into quality stocks.

Are you craving more input on these three stocks? Start by adding them to your free and personalized watchlist so you can keep track of the latest news with each company.

Also, if you're tired of chasing stocks with questionable potential, then I invite you to download a copy of our latest special report, "The Motley Fool's Top Stock for 2012." This report highlights a company that our chief investment officer has dubbed the "Costco of Latin America." Best of all, this report is completely free to you for a limited time, so don't miss out!

At the time this article was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He was, at one time, an avid Simpsons watcher. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy whose foundation is the truth.

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