The S&P 500 ended 2011 almost exactly where it started.  If ever there was a year when being invested in the right companies, and selling the dogs, mattered for higher portfolio returns it was 2011.  The good news is that many of the 2011 dogs were easy to spot, and easy to sell before ruining your portfolio. 

There were many bad performers.  However, there was a common theme.  Most simply did not adjust to market shifts.  Environmental changes, from technology to regulations, made them less competitive thus producing declining returns as newer competitors benefitted.  Additionally, these companies chose – often over the course of several years – to eschew innovation and new product launches.  They chose to keep investing in efforts to defend and extend historical, but troubled, businesses rather than innovate toward a more successful future.

Looking at the trends that put these companies into trouble we can recognize the need to continue avoiding these companies, even though many analysts are starting to say they may be "value stocks." Instead we can invest in the trends by buying companies likely to grow and increase portfolio returns in 2012.

Avoid Kodak – Buy Apple or Google

Few companies are as iconic as Eastman Kodak, inventor of amateur photography and creator of the star product in the hit 1973 Paul Simon song "Kodachrome." However, it was clear in the late 1980s that digital cameras were going to change photography.  Kodak itself was one of the primary inventors of the core technology, but licensed it to others in order to generate cash it invested trying to defend and extend photographic film and paper sales.  In my 2008 book "Create Marketplace Disruption" I highlighted Kodak as a company so locked-in to film sales that it was unwilling to even consider moving into new markets.

In 2011 EK lost almost all its value, falling from $3.85 share to about 60 cents.  The whole company is now worth only $175M as it rapidly moves toward NYSE delisting and bankruptcy, and complete failure.  The trend that doomed EK has been 2 decades in the making, yet like an ocean freighter collision management simply let momentum kill the company.  The long slide has gone on for years, and will not reverse.  If you want to invest in photography your best plays are smart phone suppliers Apple, and Google for not only the Android software but the Chrome apps that are being used to photoshop images right inside browser windows.

Avoid Sears – Buy Amazon

When hedge fund manager Ed Lampert took over KMart by buying their bonds in bankruptcy, then used that platform to buy Sears back in 2006 the Wall Street folks hailed him as a genius. "Mad Money" Jim Cramer said "Fast Eddie" Lampert was his former college roommate, and that was all he needed to recommend buying the stock.  On the strength of such spurrious recommendations, Sears Holdings initially did quite well.

However, I was quoted in The Chicago Tribune the day of the Sears acquisition announcement saying the merged company was doomed – because the trends were clear.  Wal-Mart was in pitched battle with Target to "own" the discount market which had crushed KMart.  Sears was pinched by them on the low end, and by better operators of vertically focused companies such as Kohl's for clothing, Best Buy for appliances and Home Depot for repair and landscape tools.  Sears was swimming against the trends, and Ed Lampert had no plans to re-invent the company.  What lay ahead was cost-cutting and store closings which would kill both brands in a market already overly saturated with traditional brick-and-mortar retailers as long-term more sales moved on-line.

Now Sears Holdings has gone full circle.  In the last 12 months the stock has dropped from $95 to $31.50 – a decline of more than two thirds (a loss of over $7B in investor value.)  Sears and KMart have no future, nor do the Craftsman or Kenmore brands.  After Christmas management announced a new round of store closings as same stores sales continues its never-ending slide, and finally most industry analysts are saying Sears has nowhere to go but down. 

The retail future belongs to Amazon.com – which is where you should invest if you want to grow portfolio value in 2012.  Look to Kindle Fire and other tablets to accelerate the retail movement on-line, while out-of-date Sears becomes even less relevant and of lower value.

Stay out of Nokia and Research in Motion – Buy Apple

On February 15 I wrote that Nokia had made a horrible CEO selection, and was a stock to avoid.  Nokia invesors lost about $18B of value in 2001 as the stock lost  50% of its market cap in 2011 (62% peak to trough.) May 20 I pounded the table to sell RIMM, which lost nearly 80% of its investor value in 2011 – nearly $60B! 

Both companies simply missed the market shift in smart phones.  Nokia did its best Motorola imitation, which missed the shift from analog to digital cell phones – and then completely missed the shift to smart phones – driving the company to near bankruptcy and acquisition by Google for its patent library.  With no game at all, the Nokia Board hired a former Microsoft executive to arrange a shotgun wedding for launching a new platform – 3 years too late.  Now Apple and Android have over 400,000 apps each, growing weekly, while Microsoft is struggling with 50k apps, no compelling reason to switch and struggles to build a developer network.  Nokia's road to oblivion appears clear.

RIM was first to the smartphone market, and had it locked up for years.  Unfortunately, top management and many investors felt that the huge installed base of corporate accounts, using Blackberry secure servers, would protect the company from competition.  Now the New York Times has reported RIM leadership as one of the worst in 2011, because an installed base is no longer the competitive entry barrier Michael Porter waxed about in the early 1980s.  Corporations are following their users to better productivty by moving fast as possible to the iOS and Android worlds. 

RIM's doomed effort to launch an ill-devised, weakly performing tablet against the Apple iPod juggernaut only served to embarrass the company, at great expense.  At this point, there's little reason to think RIM will do any better than Palm did when the technology shifted, and anyone holding RIMM will likely end up with nothing (as did holders of PALM.)  If you want to be in mobile your best pick is market leading and profitably growing Apple, with a second position in Google as it builds up ancillary products like Chrome to leverage its growing Android base.

 Avoid HP and Sony – Buy Apple

Speaking of Palm, to paraphrase Senator Dirkson "that billion here, a billion there" that added up to some real money lost for HP.  Mark Hurd consolidated HP into a company focused on building volume largely in other people's technology – otherwise known as PCs.  As printing declines, and people shift to tablets and cloud apps, HP has less and less ability to build its profit base. The trends were all going in the wrong direction as market shifts make HP less and less relevant to consumer and corporate customers. 

Selecting Mr. Apotheker was a disastrous choice, and I called for investors to dump the stock when he was hired in January.  An ERP executive, he was firmly planted in the technology of the 1990s.  With a diminished R&D, and an atrophied new product development organization HP is nothing like the organization of its founders, and the newest CEO has offered no clear path for finding the trends and re-igniting growth at HP.  If you want to grow in what we used to call the PC business you need to be in tablets now – and that gets you back, once again, to Apple first, and Google second.

Which opens the door for discussing what in the 1960s through 1980s was the most innovative of all consumer electronics companies, Sony.  But when Mr. Morita was replaced by an MBA CEO that began focusing the company on the bottom line, instead of new gadgets, the pipeline rapidly dried.  Acquisitions, such as a music label, replaced R&D and new product development.  Allegiance to protecting the CD and DVD business, and the players Sony made – along with traditional TVs and PCs – meant Sony missed the wave to MP3, to mobile digital entertainment devices, to DVRs and the emerging market for interactive TV.  What was once a leader is now a follower. 

As a result Sony has lost $4.5B in investor value the last 3 year, and in 2011 lost half its value falling from $37 to $18/share.  As Apple emerges as the top consumer electronics technology leader and profit creator, closely chased by Google, it is unlikely Sony will ever recover that lost value. 

Buying Apple, Amazon, Google and Netflix

This column has already made the case for Apple.  It is almost incomprehensible how far a lead Apple has over its competition, causing investors to fear for its revenue growth prospects.  As a result, the companies P/E multiple is a remarkably low single-digit number, even though its growth is well into the double digits!  But its existing position in growth markets, technology leadership and well oiled new product development capability nearly assures continued profitbale growth for at least 5 years.  Even though the stock, which I recommended as my number 1 buy in January, 2011, has risen some 30% maintaining a big position is remains an investors best portfolio enhancer.

Amazon was a wild ride in 2011, and today is worth almost the same as it was one year ago.  Given that the company is now larger, has a more dominant position in publishing and is the world leader on the trend to on-line retail it is a very good stock to own.  The choice to think long-term and build its user links through sales of Kindle Fire at cost has limited short-term profits, but every action Amazon has taken to grow has paid off handsomely because they accelerate the natural trends and position Amazon as the leader.  Remaining with the trends, and the growth, offers the potential for big payoff this year and for years to come.

Google remains #2 in most markets, but remains aligned with the trends.  It was disappointing that the company cancelled so many great products in 2011 – such as Gear and Wave. And it faces stiff competition in its historical ad markets from the shift toward social media and Facebook's emergence.  However, Google is the best positioned company to displace Microsoft on all those tablets out there with its Chrome apps, and it still is a competitor with the potential for long-term value creation.  It's just hard to be as excited about Google as Apple and Amazon. 

Netflix started 2011 great, but then stumbled.  Starting the year at $190, Netflix rose to $305 before falling to $75.  Investors have seen an 80% decline from the peak, and a 60% decline from beginning of the year.  But this was notably not because company revenues or profits fell, because they didn't.  Rather concerns about price changes and long-term competition caused the stock to drop.  And that's why I remain bullish for owning Netflix in 2012.

Growth can hide a multitude of sins, as I pointed out when making the case to buy in October.  And Netflix has done a spectacular job of preparing itself to transition from physical DVDs to video downloads.  The "game" is not over, and there is a lot of content warring left.  But Netflix was first, and has the largest user base.  Techcrunch recently reported on a Citi survey that found Netflix still has nearly twice the viewership of #2 Hulu (27% vs. 15%.) 

Those who worry about Amazon, Google or Apple taking the Netflix position forget that those companies are making huge bets to compete in other markets and have shown less interest in making the big investments to compete on the content that is critical in the download market.  AOL and Yahoo are also bound up trying to define new strategies, and look unlikely to ever be the content companies they once were.

For those who are banking on competitive war with Comcast and other cable companies to kill off Netflix look no further than how they define themselves (cable operators,) and their horrific customer relationship scores to realize that they are more interested in trying to preserve their old business than rapidly enter a new one.  Perhaps one will try to buy Netflix, but they don't have the management teams or organization to compete effectively.

The fact is that Netflix still has the best strategy for its market, which is still growing exponentially, has the best pricing and is rapidly growing its content to remain in the top position.  That makes it a likely pick for "turnaround of the year" by end of 2012 (at least in the tech/media industry) – even as investments rise over the next 12 months.

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