Here's Why Fundamental Investing is Flawed

Just came across a post about why Lucent might be a good buy over at The Stock Market Blog.

He talks about the attractiveness of buying the stock because its fantastic cash flow and its monstrous 13% dividend.

Yes, you read that right. Lucent, the voice, data, and video communication services company, pays a very high yield. This particular stock is not the Lucent common stock that used to trade on the NYSE under the symbol LU, nor is it the Alcatel-Lucent (ALU) common stock which is the result of the merger between French communications company Alcatel with Lucent. Of course, I'm talking about Lucent's preferred stock, with the official name of Lucent Technologies Capital Trust I (LUTHP.PK). This is a 7.75% Cumulative Convertible Trust Preferred Security which was first issued in 2002. The stock pays $19.375 per quarter, giving it a current yield of 10.2%.

If you think that Alcatel-Lucent is a survivor, and you like high income, it may be worth taking a closer look at this investment. It is convertible into the common shares but it is far away from conversion, as the conversion share price is 24.80. Could the common go that high before 3/15/2017, the trust's maturity date? Stranger things have happened, but even if it doesn't, as long as the company stays in business, you will also make about $240 per share in capital appreciation as the stock recently traded at $760 per share. This boosts the yield even higher, giving it a yield to maturity in excess of 12.9%.

Will Alcatel-Lucent survive? The stock is trading at its cash per share, which doesn't mean much, as the company carries a huge amount of debt at $6.1 billion. On the plus side, it has the same amount of cash. Although the company has been reporting negative earnings, the operating cash flow has been running at $380 million and levered free cash flow is at $1.1 billion.

 The problem is that, like most fundamental investors, there's no mention of how many shares we should buy and at what point we should cut and run if the investment is not going in our favor. Now, I don't expect him to tell us these things, but he seems like the type of investor who doesn't worry about limiting his risk and cutting his losers short. He's in for the long haul on Lucent. And that strategy may be working well for him. He might have a decent buy and hold strategy in his mind with rules for getting in and out that he doesn't reveal to us. But for the most part, most buy and hold investing strategies are just seat-of-the-pants appeals to gut feeling. You just have a good feeling for something and go for it. The problem is that when you don't look where you leap, you might find that you don't like where you land a lot of the time.