Does valuation matter?
There are moments in time when it does not. We are seeing one of those moments today.
To that, I say be very careful. Buying stocks simply because the market is rising is a dangerous game. Any number of things can change the mood and do so very quickly.
As they say, you don’t want to be caught holding the bag.
One of the triggers for a downswing in the market is the quarterly earnings report. When a company reports operating results the market can better judge what a company is worth. If that new valuation differs greatly from where the stock currently trades, fireworks can occur.
It is not unusual to see stocks move 5% to 10% after announcing profit numbers. In some cases the gains or losses can be even more.
In the current market environment, stocks are in full-blown rally mode. Perhaps you’ve been distracted by the noise of political debate over the fiscal cliff or other issues to notice, but stocks added double digits last year. So far in January, stocks have added another 4% to the tally.
The gains put many names at 52-week highs if not multi-year highs. A high in and of itself is not a bad thing, but if the valuation is excessive the earnings report becomes even more important to the narrative.
Miss the number and look out below.
Here are three names to jettison before they report results on Thursday, January 24th:
The multinational industrial company is at risk for a big decline. One of the big consequences of the fiscal cliff debate was a freezing of much economic activity during the fourth quarter. Such indecisiveness by CEOs on purchases and hiring will likely negatively impact earnings at 3M (NYSE:MMM). A poor report would not be welcome news for investors who have bid up 3M shares. Analysts expect 3M to grow profits by less than 10% in 2013. At current prices, shares trade for 14 times 2013 earnings.
On some level you could argue that a higher valuation is justified given the dividends paid by the company, but let’s not make this too complicated. Equity investors generally pay a premium for growth. If that growth isn’t there, the valuation at some point will deteriorate.
Look for this week’s earnings to disappoint and shares to step back from current highs.
See also: 25 Widely-Held Stocks to Dump Now
What can you say about Microsoft (NASDAQ:MSFT)? The old software giant is about as nimble as an elephant. The monopoly in software operating systems allowed such a state, but the competitive landscape has changed dramatically. It’s only a matter of time for Microsoft to really feel the pain. The collapse in personal computing will take a big chunk out of Microsoft’s fat profits. The recent launch of Windows 8 is not likely to help much.
This is one stock you don’t have to worry much about appreciating. The future trajectory for this one is lower. This week’s earnings will simply be the next leg down for Microsoft.
There was a time when AT&T (NYSE:T) ruled the smartphone world with its exclusive arrangement with Apple. Investors are probably wishing for a return to those days. Since the end of that exclusivity, AT&T has done little. Where is the profit growth coming from?
We will learn more from the company when it reports earnings next week. Don’t be fooled by the 5% dividend yield. There is trouble owning this stock at these levels.
Mainly, profit growth isn’t there. Analysts expect profits to improve by 7% in 2013. At current prices, the stock trades for 13 times 2013 estimated earnings. Paying double the expected growth rate simply does not add up. And let us not forget about potential problems at Apple (NASDAQ:AAPL). Sales there might be weak.
If so, AT&T could be in for some real pain. I’d sell this one before the news.