by Dan Burrows | May 3, 2013 1:48 pm
Kraft Foods (NASDAQ:KRFT) has been on a heck of a run since being spun off from Mondelez (NASDAQ:MDLZ) last fall, and shares popped again Friday on better-than-expected earnings.
But don’t break out the Velveeta and Kool-Aid to celebrate just yet.
If you need an example of how the Federal Reserve’s policy of crushing interest rates is messing with equity valuations, Kraft is as good an example as any.
Rates are so low that bonds yields are dying from hunger. That has money pouring into dividend stocks like Kraft — with buyers paying some pretty nutty premiums for names with ho-hum growth.
Kraft, whose brands include such pantry staples as Oscar Mayer, Planters and Jell-O, was split off from the rest of the business to focus solely on the slow-growth North American market. Mondelez, which got the snack brands like Cadbury and Oreo, is supposed to be the growthier company doing business in rapidly expanding emerging markets.
So why the heck is Kraft’s stock up 20% since the spin off, clobbering the broader market by 8 percentage points? (Mondelez is up 21% over the same span.)
Because it’s a consumer staples stock paying out a fat 3.7% forward yield on its dividend, that’s why.
Just look at what the market is doing in 2013, and you’ll see that “growth” doesn’t matter these days; dividends do.
In a year when the S&P 500 is up 13% and topping 1,600 for the first time ever, it is being led by defensive dividend payers.
Indeed, for the year-to-date, the top performing sectors of the S&P 500 are all defensive dividend payers: healthcare, up more than 18%; consumer staples, up more than 17%; utilities, up 17%.
Meanwhile, the technology sector — that supposed redoubt of outsized growth prospects and comparatively much lower dividend payouts — has gained just 5.7%.
How bad is that? Only the super-cyclical materials sector has fared worse (thanks to slumping global growth and the attendant deflation in commodity prices.)
For crying out loud, the telecommunications sector is up nearly 14% for the year on a price basis alone.
In a world where benchmark 10-year Treasury notes can’t keep their yields above 2%, dividend stocks have become the new bonds. (Even though dividend stocks are not — repeat, not — bonds.)
But that’s how an income-starved market is treating them.
Which brings us to the problem with initiating a position in Kraft at current levels. The hunger for yield has made it too pricey — maybe not for a trade, but definitely for a long-term hold (which is what this widows-and-orphans name really is, anyway.)
Put simply, Kraft’s stock is simply too expensive for its growth prospects, which are less than modest.
If you buy Kraft today, you will pay 17 times forward earnings — a forward price-to-earnings ratio (P/E) of 17.
But Kraft is forecast to grow earnings at an average annual rate of only 5.9% for the next half-decade. For that kind of growth, in normal times — even with the dividend — you might pay 12 or 15 times forward earnings.
It’s far more expensive than the S&P 500, as well. The broader market has long-term growth rate of 9.3% and a forward P/E of 13.9. So the S&P 500 is both cheaper and has better growth prospects.
And, as a result, it has a much lower PEG, or price/earnings-to-growth ratio, which measures how fast a stock is rising relative to its future earnings potential. The S&P 500 sports a PEG of 1.7.
Kraft’s stands at 3.1.
Here’s how crazy some valuations have become: Kraft is more expensive than Google (NASDAQ:GOOG), which fetches 16 times forward earnings despite have a long-term growth forecast of 15%. Oh, and a PEG ratio of just 1.2.
Indeed, taking PEG alone, Kraft looks more like Amazon (NASDAQ:AMZN) — at 3.9 — than a company that sells Cool Whip and Capri Sun.
Kraft isn’t rising on accelerating earnings growth (profit actually declined in the most recent quarter.) Rather, it’s rising because buyers are willing to pay higher and higher premiums for future earnings — also known as multiple expansion.
The problem is that given enough time, multiples tend to revert to the mean. Kraft can certainly have more upside from here in the shorter term. But as a widows-and-orphans stock — something you want to buy and hold forever — that premium valuation today consigns it to a long period of underperformance somewhere down the road.
As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.
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