Pending Lawsuit Hurting SCI Stock, Expert Says “Look, But Don’t Touch”

In the stock market, bad news brings out buzzards and buyers. The birds are circling to see if the company is dead, the buyers are figuring things will get better when the news passes.

It’s a bit like being an interested observer as you drive by a car accident, with one key difference; rubberneckers aren’t thinking of purchasing the wreck.

Investors, however, look at every headline as a potential opportunity, even one as unpleasant as the recent news that Service Corp. International, the Texas-based cemetery company, was facing a new class-action suit over allegations that it mismanaged and desecrated a cemetery in Florida.

What investors may see is a company that has gained nearly 40% since the start of 2010, and they figure the lawsuit news will put it on sale for a short time.

What they are getting in Service Corp. International, however, is the Stupid Investment of the Week.

Stupid Investment of the Week highlights the conditions and characteristics that make a security less than ideal for the average investor and is written in the hope that spotlighting the flawed logic and dangers in one situation will make it easier to avoid trouble elsewhere. While obviously not a purchase recommendation, the column is not intended as an automatic sell signal.

Indeed, SCI supporters might recognize that this is not the company’s first time at the SIOTW rodeo, having received the distinction in late October 2008.

The stock was more than cut in half over 20 weeks — in line with my expectations for the stock — but rebounded sharply as the market turned, finishing 2009 with a gain of nearly 70% before starting a slower-but-steady climb since. See what I said about SCI in 2008.

Companies get hit with lawsuits all the time and typically can withstand the heat, even though they may suffer for it.

The issue with SCI is that if it loses the current lawsuit, it could suffer a devastating blow to a fragile balance sheet.

Before getting to that, however, consider the simple case for buying the stock.

The appeal of investing in the funeral business is that it has customers regardless of market conditions. As the baby boom generation hits retirement age, the common assumption is that demand for funeral services will be growing.

Service Corp. is the largest provider of death-care products and services in North America, with a network of more than 1,250 funeral-service locations and roughly 375 cemeteries, including some 200-plus combination locations, where a funeral home is in proximity to a cemetery. The company performs about 5,000 funeral services and 8,000 interments per year.

Much of the focus of the death-services business has moved to what is called “pre-need planning,” and SCI has built up a tremendous store of future business, a “pre-need backlog” of some $5.8 billion in future revenues, according to the company’s 2011 annual report.

While there is no telling when those revenues will arrive — the company earns interest on its trusts, but it only collects on the contracts when the trust owner dies — there’s no doubt that the company is securing its share of the never-ending demand for its services.

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