Buying This Stock Is Like Purchasing a Lottery Ticket

By Markets Fool.com

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Source:Flickr user Mark Ou.

We at the Fool believe that investing shouldn't be too much of a gamble. With a little discipline and some informed decisions, it should be possible to build a portfolio of solid stocks that produce good returns and still let you sleep at night.

Having said that, some stocks are just as much of a gamble as buying lottery tickets, and investors need to know the risks before considering them. Here are three stocks that could produce a "jackpot"-like payoff or could destroy your investment just as easily.

Selena Maranjian
It may seem tempting to buy stock in RadioShack Corporation , given that its shares have fallen 90% over the past year to a recent price of $0.24 per share. At this point, however, any investment in RadioShack stock is little more than speculation, rather than reasoned investing, because the company's future looks shaky. The stock price is extremely low, but there's no reason to think that a $0.24 stock can't become a $0.10 stock -- many have.

A glance at RadioShack's financial statements is telling. Revenue topped $5 billion in 2005 and was recently around $3.4 billion. Sales that top $3 billion may sound impressive, but not if they don't translate to earnings on the bottom line. RadioShack's earnings per share in 2005 was $1.79, and in the past 12 months, the company has suffered a loss of $3.79 per share. (RadioShack has posted losses in the last 11 quarters.) Free cash flow has turned negative, and gross margins have dropped from about 50% a decade ago to about 34%, while net margins reflect widening losses. The company has been hurt by the growth of e-commerce and has not gotten much of a boost from the growth of smartphones.

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All this has not been lost on Wall Street, as the stock's performance shows. The New York Stock Exchange, on which it's listed, suspended trading of RadioShack shares on Monday because the company's market capitalization has fallen below $50 million. RadioShack has more than $600 million in long-term debt and has delayed some rent payments; many analysts expect the company to file for bankruptcy protection soon. Like most lottery tickets, RadioShack stock is likely to leave you disappointed and out some money.

Matt Frankel
Another stock that looks risky as a lottery ticket is Fannie Mae , which, along with its sibling, Freddie Mac , trades for just over $2 per share.

Fannie Mae rebounded from pennies per share just a couple of years ago once the agency became profitable again, but there's one big problem. Thanks to the arrangement with the U.S. Treasury stemming from the financial-crisis bailout, 100% of Fannie's profits go straight to the U.S. government as a "dividend" on its bailout investment.

Several high-profile investors, including Pershing Square's Bill Ackman, are currently suing the government to change the arrangement, which they call unconstitutional and unfair to investors. And it's hard to disagree with their logic: They took the chance to buy shares when the agencies were left for dead. Now that Fannie and Freddie have returned to profitability, shouldn't investors be rewarded?

One judge has already said no and dismissed several of the lawsuits. Further, there is an ongoing congressional effort to dismantle Fannie and Freddie. No one has agreed on how to do it just yet, but the threat is real.

One win-win theory put forth by Ackman claims that Fannie Mae's shares could be worth as much as $47 each, and the government could see $600 billion in profits. While a 20-bagger sounds great in principle, this one is just too much of a long shot.

Dan Caplinger
One stock that I liked in the past but that now has lottery-ticket characteristics is Cliffs Natural Resources . Cliffs is in the business of producing iron ore and metallurgical coal, and both of those commodity markets have performed terribly in recent years as demand from steel producers has waned. In particular, weakness in the Chinese economy has hurt the global steel industry, and given that few economists expect spending on steel-intensive industries like construction or infrastructure to resume at previous levels, steel prices could remain low for a long time. Already Cliffs has had to eliminate what used to be an attractive dividend to preserve cash, and ill-timed acquisitions have created financial burdens that the company has had increasing difficulty bearing.

The Powerball moment for Cliffs, though, could come if demand for U.S.-made steel climbs. Cliffs has the geographical advantage of being close to home for U.S. steel producers, and the strengthening domestic economy could lift demand for steel even if global prices remain low. With its current financial problems, Cliffs needs such a turnaround to occur relatively soon, but if the downward phase of the business cycle ends in time, then Cliffs' beaten-down shares could be poised for a huge recovery.

The article Buying This Stock Is Like Purchasing a Lottery Ticket originally appeared on Fool.com.

Dan Caplinger and Selena Maranjian have no position in any stocks mentioned. Matthew Frankel and The Motley Fool own shares of Cliffs Natural Resources. 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.