Beware the Broken Businesses

In February, some investors clamored to buy shares of virtual penny-stock Talbots (NYS: TLB) , fired up by the idea it might be acquired by private equity firm Sycamore Partners. Flash forward several months and this stock's story still centers around its sad business outlook.

Last week, Talbots revealed more dismal tidings. The retailer warned that it expects first-quarter sales to fall by 9.6% to $272 million on a year-over-year basis. Although that top-line figure does beat analysts' dismal expectations, it certainly shows this business is still broken (as it has been for years, really). Talbots will also report a first-quarter loss, compared to a profit this time last year.

Investors' acquisition-rumor-fired fever -- which is really quite similar to the kind of disconnection from reality that often occurs in Vegas casinos -- has buoyed stocks of some pretty pathetic companies lately. Take Avon Products (NYS: AVP) , which, like Talbots, recently rebuffed a potential suitor and continues to claim Coty's bid is just not high enough.

Last week, rumors that grocery giant Safeway (NYS: SWY) could be a takeover candidate fired up the stock by the largest amount since 2009, resulting in a 7.5% jump. Apparently some investors aren't deterred by things that make the concept sound outlandish on many levels.

Safeway has a market cap of $5.72 billion but its enterprise value is about double that. In other words, it's weighed down with debt obligations. Some analysts have also pointed out that Safeway has onerous pension liabilities. How many buyers would sign up under those circumstances? Personally, I don't buy it.

Talbots' stock plunge last week surely shows at least some investors suddenly realized hinging hopes on an acquisition at $3 per share or more was probably a bad gamble. But some Talbots investors still may be waiting for good news that has nothing to do with whether Talbots' business is even capable of being fixed after longtime malaise and ongoing brand damage.

Investors are far better off sticking with stocks of strong companies and holding for the long haul instead of buying up shares of rumor-riddled broken businesses. For example, take Costco (NAS: COST) ; that strong retailer's shares have recently retreated from recent highs. Although Costco missed analysts' same-store sales expectations for March, the discount retailer still reported a 6% increase in U.S. same-store sales and a 7% jump in international comps. Any temporary weakness in Costco shares simply reflects an opportunity to get a better deal for shares of a great company.

Messing around with broken businesses that have little hope other than a takeover is risky business for investors. Leave the gambling in Vegas. Instead, you should make calculated and well-informed purchases. Fortunately, we've already done a lot of the heavy lifting for you. Learn about The Motley Fool's Top Stock for 2012 by clicking here now.

At the time thisarticle was published Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services have recommended buying shares of Costco Wholesale. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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