Investing for Beginners: When "Buy What You Know" Is a Bad Idea

Yesterday, I showed how investing for beginners doesn't have to be as daunting as you might think. As someone who participates in our economy every day, there are lots of great companies you already know about. Many times, buying shares of these companies is a great investment decision.

Unfortunately, that won't always be the case. Sometimes, our favorite companies have poor business models; other times, management can be corrupt; and worse yet, there are some companies that make money in ways that are very difficult to comprehend.

This is why "buy what you know" is a great place to start, but requires continual learning. Below are a few examples of companies that are relatively well known but might not be the best investing choices for beginners.

Pandora (NYSE: P  )

Source: Pandora. 

Who doesn't love Pandora? I paid the $32 yearly fee for commercials to be taken out, and it's on in my house for hours every day. It's a company whose service I love, but beginners have to realize that there's more than meets the eye.

Every time Pandora plays a song, it has to pay a royalty fee for that song. That means that every song you listen to costs Pandora money. The only way to make up the difference is through advertising. As people listen to more and more music, advertising revenues need to keep pace.

So far, that doesn't seem to be the case. In 2012, Pandora's revenue from advertisers grew 56%. That's not bad at all. Unfortunately, the amount of money the company had to pay in royalty fees grew by 74%. That means that as Pandora got more popular, it was actually losing more money. That's not the greatest business model when we're focusing on investing for beginners.

Diamond Foods (NASDAQ: DMND  )

Source: Wikimedia Commons. 

Though the name might not immediately sound familiar, Diamond Foods is one of the leading providers of snacks in the United States. The company's assorted nut snacks are sold under the "Diamond" name, but it also offers Kettle Brand potato chips, Emerald trail mixes, and Pop Secret popcorn.

That's a relatively easy-to-understand business -- but with Diamond, there's a catch. Management had been fudging their accounting numbers for quite a while to meet outsize expectations and to help extract huge bonuses. When investors found out, the stock plunged 70%.

This is the kind of risk that's difficult for investing professionals, let alone beginners, to spot. It highlights the importance of continuing investing education as you grow more accustomed to your investments.

Big banks
The vast majority of Americans use one of the country's big four banks: JPMorgan Chase, Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , and Wells Fargo (NYSE: WFC  ) . It's easy enough to understand that a bank pays you interest to hold your money, lends that money out to others for a higher interest rate, and keeps the difference for itself.

But that's not the only way banks can make money. There are derivatives, credit default swaps, and collateralized debt obligations, to name a few. If you'd like to spend a few years really grasping these instruments, go for it. But even some of the former CEOs of these banks admit they don't know how it all works.

Investing for beginners can be made much more simple by focusing on companies that make money in ways that even a kindergartner could understand. Big banks simply don't fall under that category.

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What it all means for beginning investors
There are literally thousands of companies that you can invest in. One way of narrowing down that list is by noting which companies you are already familiar with. This should give you a much more manageable universe of stocks to pick from.

From there, you've got to put in a little legwork yourself, to ensure you understand what you are investing in. Remember, at the beginning, the simpler the investment, the better. Don't get in over your head -- learning about investing can be a lifelong pursuit.

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Panera Earnings Look Primed to Rise Higher

Panera Bread (NASDAQ: PNRA  ) will release its quarterly report tomorrow, and investors are hoping that the company will be able to produce the same growth that its rapidly rising stock price has promised. As with most high-growth stocks, Panera earnings will need to accelerate to make shareholders truly happy.

Panera has been one of the best growth stories in the restaurant sector, with the company having capitalized on greater demand for healthy food offerings by producing a welcoming café atmosphere. Yet will the bakery chain be able to keep growing at its breakneck pace for the foreseeable future? Let's take an early look at what's been happening with Panera Bread over the past quarter and what we're likely to see in its quarterly report.

Stats on Panera Bread

Analyst EPS Estimate	$1.77
Change From Year-Ago EPS	18%
Revenue Estimate	$596.02 million
Change From Year-Ago Revenue	12.3%
Earnings Beats in Past 4 Quarters	3

Source: Yahoo! Finance.

Will Panera earnings keep rising like yeasty bread dough?
Analysts have tightened up their estimates on Panera earnings only by the smallest of margins, pulling back on their June-quarter estimates by a penny per share and reducing their full-year 2013 calls by twice that. Yet the stock hasn't responded badly to those moves, with shares up between 2% and 3% since mid-April.

Panera's success has come largely from the willingness of consumers to pay up for high-quality food. Chipotle Mexican Grill's (NYSE: CMG  ) recent results from last week gave further evidence of this, as Chipotle bounced back from a somewhat weak first quarter to post 5.5% comparable-store sales that produced overall revenue gains of more than 18%. Given that Panera's first-quarter results were stronger than Chipotle's, investors hope that Panera can raise the bar even higher this time around.

Co-CEOs Ronald Shaich and Bill Moreton have been an important part of what's gotten Panera to where it is today. Partnerships with high-quality food and beverage suppliers have helped Panera deliver more of what customers are looking for. Moreover, even though the company hasn't been the first-mover in many of its moves -- it chose the same supplier that McDonald's (NYSE: MCD  ) uses for its gourmet coffee, and Starbucks (NASDAQ: SBUX  ) first started emphasizing natural and organic food offerings -- Panera has been smart about taking those themes and applying them more specifically to its own business.

Moreover, Panera's overall strategy has been working. In a recent consumer survey, Chipotle managed to come in ahead of Panera in terms of willingness to pay extra money for healthier food by a 31% to 19% margin. But Panera beat out Starbucks, and with new pasta, salad, and wrap offerings, Panera looks poised to try to capture a larger share of the healthy-eating market.

In the Panera earnings report, watch to see if the same trends that helped Chipotle also show up in Panera's numbers. As the economy continues to recover, Panera has a chance to accelerate its growth by catering to the demand for quality at a reasonable price.

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Why SCANA's Earnings May Not Be So Hot

Although business headlines still tout earnings numbers, many investors have moved past net earnings as a measure of a company's economic output. That's because earnings are very often less trustworthy than cash flow, since earnings are more open to manipulation based on dubious judgment calls.

Earnings' unreliability is one of the reasons Foolish investors often flip straight past the income statement to check the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can better understand whether the last batch of earnings brought money into the company, or merely disguised a cash gusher with a pretty headline.

Calling all cash flows
When you are trying to buy the market's best stocks, it's worth checking up on your companies' free cash flow once a quarter or so, to see whether it bears any relationship to the net income in the headlines. That's what we do with this series. Today, we're checking in on SCANA (NYSE: SCG  ) , whose recent revenue and earnings are plotted below.

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. Dollar values in millions. FCF = free cash flow. FY = fiscal year. TTM = trailing 12 months.

Over the past 12 months, SCANA burned $200.0 million cash while it booked net income of $450.0 million. That means it burned through all its revenue and more. That doesn't sound so great. FCF is less than net income. Ideally, we'd like to see the opposite.

All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense, either. That's why it pays to take a close look at the components of cash flow from operations, to make sure that the cash flows are of high quality. What does that mean? To me, it means they need to be real and replicable in the upcoming quarters, rather than being offset by continual cash outflows that don't appear on the income statement (such as major capital expenditures).

For instance, cash flow based on cash net income and adjustments for non-cash income-statement expenses (like depreciation) is generally favorable. An increase in cash flow based on stiffing your suppliers (by increasing accounts payable for the short term) or shortchanging Uncle Sam on taxes will come back to bite investors later. The same goes for decreasing accounts receivable; this is good to see, but it's ordinary in recessionary times, and you can only increase collections so much. Finally, adding stock-based compensation expense back to cash flows is questionable when a company hands out a lot of equity to employees and uses cash in later periods to buy back those shares.

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So how does the cash flow at SCANA look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. Dollar values in millions. TTM = trailing 12 months.

When I say "questionable cash flow sources," I mean items such as changes in taxes payable, tax benefits from stock options, and asset sales, among others. That's not to say that companies booking these as sources of cash flow are weak, or are engaging in any sort of wrongdoing, or that everything that comes up questionable in my graph is automatically bad news. But whenever a company is getting more than, say, 10% of its cash from operations from these dubious sources, investors ought to make sure to refer to the filings and dig in.

With questionable cash flows amounting to only 8.9% of operating cash flow, SCANA's cash flows look clean. Within the questionable cash flow figure plotted in the TTM period above, other operating activities (which can include deferred income taxes, pension charges, and other one-off items) provided the biggest boost, at 8.9% of cash flow from operations. Overall, the biggest drag on FCF came from capital expenditures.

A Foolish final thought
Most investors don't keep tabs on their companies' cash flow. I think that's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. Better yet, you'll improve your odds of finding the underappreciated home-run stocks that provide the market's best returns.

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We can help you keep tabs on your companies with My Watchlist, our free, personalized stock tracking service.

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Top 5 Cheap Companies To Own In Right Now: Horace Mann Educators Corporation(HMN)

Horace Mann Educators Corporation, through its subsidiaries, operates as a multiline insurance company in the United States. The company underwrites and markets personal lines of property and casualty insurance, retirement annuity, and life insurance products. Its products include private passenger automobile and homeowner?s insurance coverage; tax-qualified individual and group annuities in fixed account and combination contracts; and individual and joint whole and term life insurance products. The company offers its products primarily to K-12 teachers, school administrators, education support personnel, and other employees of public schools and their families. It markets its products through its sales force, as well as through independent agents. Horace Mann Educators Corporation was founded in 1945 and is based in Springfield, Illinois.

Advisors' Opinion:

• [By Chris Stuart]

  Horace Mann Educators(HMN), which provides car and homeowners insurance for teachers and other educators, recently lowered its full-year profit forecast because of a spike in tornado- and storm-related disasters during April and May. Management reduced 2011 EPS guidance to $1.10-$1.30 from a previous $1.75-$1.95.

  With the shares down 10% over the past three months, investors might want to consider the recent dislocation as a buying opportunity. At the midrange of restated guidance, the shares are trading for 12.8 times fiscal 2011 estimates and, more importantly, at just 0.7 times book value. TheStreet Ratings has a $20 price target on Horace Mann.

Top 5 Cheap Companies To Own In Right Now: Uranium Resources Inc.(URRE)

Uranium Resources, Inc. engages in the acquisition, exploration, development, and mining of uranium properties, using the in situ recovery or solution mining process. It owns developed and undeveloped uranium properties in South Texas; and undeveloped uranium properties in New Mexico. The company?s primary customers include utilities who utilize nuclear power to generate electricity. Uranium Resources, Inc. was founded in 1977 and is based in Lewisville, Texas.

Advisors' Opinion:

• [By Louis]

  Uranium exploration, mine development and production company Uranium Resources Inc.(URRE) has watched its stock value skyrocket 179% in the past 12 months -- and it is still trading for less than $2 per share! This is even more impressive when you consider that investors fled the sector in March after the nuclear power plant crisis in Japan, causing URRE to lose close to 50%. Since its March 16 low, shares have climbed 38% to $1.92. With a 52-week trading range of 38 cents to $3.98, look for shares to make their way higher as the sector continues to rebound.

Top Performing Stocks To Own Right Now: Advance Auto Parts Inc(AAP)

Advance Auto Parts, Inc., through its subsidiaries, operates as a retailer of automotive aftermarket parts, accessories, batteries, and maintenance items. It operates in two segments, Advance Auto Parts (AAP) and Autopart International (AI). The AAP segment operates stores, which primarily offer auto parts, including alternators, batteries, chassis parts, clutches, engines and engine parts, radiators, starters, transmissions, and water pumps; accessories comprising floor mats, mirrors, vent shades, MP3 and cell phone accessories, and seat and steering wheel covers; chemicals consisting of antifreeze, freon, fuel additives, and car washes and waxes; and oil and other automotive petroleum products. This segment also provides battery and wiper installation, battery charging, check engine light reading, electrical system testing, video clinics and project brochures, loaner tool programs, and oil and battery recycling services; and sells its products through online. The AI segm ent operates stores that offer replacement parts for domestic and imported cars, and light trucks to customers in northeast and mid-Atlantic regions, as well as to warehouse distributors and jobbers in North America. As of January 1, 2011, the company operated 3,369 AAP stores, including 3,343 stores located in the northeastern, southeastern, and Midwestern regions of the United States under the Advance Auto Parts and Advance Discount Auto Parts trade names; 26 stores situated in Puerto Rico and the Virgin Islands under the Advance Auto Parts and Western Auto trade names; and 194 stores under the Autopart International trade name in the United States. It serves do-it-yourself, do-it-for-me, or commercial customers. The company was founded in 1929 and is based in Roanoke, Virginia.

Advisors' Opinion:

• [By Vatalyst]

  Advance Auto Parts (AAP) is the second largest parts retailer in the U.S. The common stock currently trades at a price to earnings ratio sits at 12.5, below its historical average of 16 and industry average of 15.7.

  Typical of Wall Street short term thinking, the madding crowd fled this stock in May, due to weak first quarter 2011 comparable store sales gain of 1.4% versus an 8.9% gain during December 2010. Price to book ratio is 4.57 whilst price to cash flow sits at 7.70, well below the industry average of 11.2.

Top 5 Cheap Companies To Own In Right Now: TII Network Technologies Inc.(TIII)

Tii Network Technologies, Inc., together with its subsidiaries, designs, manufactures, and sells products for use in the networks to service providers in the communications industry in the United States. It provides network interface devices (NID), including overvoltage surge protectors, digital subscriber line (DSL) service splitters, and customer bridge modules; building entrance terminals; and accessories comprising station protectors, customer wiring modules, electro-magnetic interference filters, and line test modules. The company also offers broadband products, such as DSL electronic products that include xDSL plain old telephone service splitters to isolate voice and data signals; Outrigger, an outdoor intelligent residential gateway; HomePlug technology that enables networking of voice, data, and audio devices through the consumers? AC power lines. In addition, it provides connectivity products consisting of connector block and terminal block products; voice over I nternet protocol products; switchable voice NID products; voice intercom systems for use in multi-dwelling units; and wire terminals and other connectivity products. Further, the company offers fiber optic products which comprise wall mount enclosures, rack mount enclosures, OSP fiber enclosures, cable assemblies, miscellaneous fiber accessories, and optic network terminals installation accessories. Additionally, it offers overvoltage surge protection products, including two and three electrode gas tubes; station overvoltage surge protectors; protector modules; and protector packs and cat 5 cat 6 protection products, as well as other surge protection products comprising a 75 ohm coaxial protector for cable networks; a 50-ohm coaxial protector for wireless service providers? cell sites; a gel-sealed Ethernet data protector; and power line/data line protectors for personal computers and home entertainment systems. The company was founded in 1964 and is headquartered in Edgewoo d, New York.

Advisors' Opinion:

• [By John Reese]

  Tii Network Technologies (NASDAQ: TIII) helps protect expensive telecom equipment with its overvoltage surge protection devices. This is especially useful during lightning strikes and power surges. Its Total Failsafe products offer modular station protectors, while its In-Line products protect broadband coaxial cables.

  Naturally, large telecom carriers like Verizon Communications (NYSE: VZ) are big customers and account for 34% of sales. DIRECTV (NASDAQ: DTV), Power & Telephone Supply and Tyco Electronics (NYSE: TEL) are also customers. With Verizon and other cell phone providers upgrading to 4G, Tii’s sales should remain very strong.

  The stock is a good buy, but it is thinly traded, so use a limit order within 10 cents of the previous day’s closing price. Buy TIII under $3.

Top 5 Cheap Companies To Own In Right Now: LifePoint Hospitals Inc.(LPNT)

LifePoint Hospitals Inc., through its subsidiaries, operates general acute care hospitals in non-urban communities in the United States. The company?s hospitals provide a range of medical and surgical services comprising general surgery, internal medicine, obstetrics, emergency room care, radiology, oncology, diagnostic care, coronary care, rehabilitation services, and pediatric services, as well as specialized services, such as open-heart surgery, skilled nursing, psychiatric care, and neuro-surgery. Its hospitals also offer outpatient services, including one-day surgery, laboratory, x-ray, respiratory therapy, imaging, sports medicine, and lithotripsy. As of December 31, 2009, LifePoint Hospitals owned or leased 47 hospitals with a total of 5,552 licensed beds in 17 states. The company was founded in 1997 and is headquartered in Brentwood, Tennessee. Lifepoint Hospitals Inc. (NasdaqNM:LPNT) operates independently of HCA Inc. as of May 11, 1999.

Advisors' Opinion:

• [By Vatalyst]

  Life Point Hospitals (LPNT) operates general acute care hospitals in growing, non urban areas in the US. It looks to acquire hospitals where it will be the sole provider to the community.

  On the earnings front, it had a good first quarter, beating analyst estimates. The common stock currently trades at a price to earnings ratio of 10.1, well below its 10 year historical average of 13.5. Its price to book ratio stands at 0.82 with price to cash flow being 5.1.

Despite a Few Loose Wires, Boeing's a Bargain

Another week, another problem with Boeing's (NYSE: BA  ) troubled commercial airplanes program.

As you've probably heard by now, inspections centering on a Honeywell (NYSE: HON  ) -manufactured emergency transmitter, that may or may not have been related to a fire aboard an Ethiopian Airlines-operated 787 two weeks ago, have revealed multiple instances of "wiring damage" aboard 787s in the service of airlines ANA and United Continental (NYSE: UAL  ) . This news -- part of a litany of woes involving Boeing planes these past few weeks -- helped to shave 1.3% off Boeing's share price over the course of the week.

But don't you be distracted. Don't lose sight of the bigger picture. Because as frightening as some of these headlines may be to investors, the truth is that Boeing is flying along just fine.

You see, in addition to all the wondering about wiring, we also got some definitively good news out of Boeing last week -- its Q2 earnings report, which came out Wednesday, and featured:

11% earnings growth to $1.41 per share. Revenues up 9%. Operating profit margins up 40 basis points. Operating cash flow that nearly quadrupled to $3.5 billion.

To top it all off, here at the halfway mark, Boeing increased its earnings guidance for the full year to as much as $5.30 per share and said that revenues could come in as high as $86 billion as cuts to defense and space exploration spending turn out to be not quite so deep as feared.

A bit of perspective, please
To put it mildly, these are not the kind of numbers you'd expect to see from a company in trouble, and whose customers fear to buy its products. Actually, the contrary is more likely true.

You see, crucial to the good news at Boeing is that backlog at the company grew $40 billion, largely from new orders received in the second quarter. That means Boeing's order book grew 11%, or, put another way, Boeing is taking in orders even faster than it collects revenue on old orders already delivered -- a clear indication that revenue growth is accelerating.

Valuation
How fast is Boeing growing? Analysts say earnings will grow upwards of 13% annually over the next five years. Meanwhile, the company's stock sells for just 10.2 times trailing free cash flow. That suggests that Boeing is stock is cheap even if growth is not accelerating.

Now, add on a 1.8% dividend tailwind, and I think the investors who sold Boeing shares last week have made a big mistake. This stock is a bargain, and despite a few issues with its newest plane, Boeing won't just survive. It'll downright thrive.

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