5 Worst Blue Chips to Own Before Earnings

by Jeff Reeves | October 8, 2013 11:26 am

[1]The Dow Jones Industrial Average has had quite a year, with the blue-chip index adding about 14%.

That’s not quite as much as the S&P 500, of course, but keep in mind that the Dow also just gave itself a facelift by booting[2] also-ran aluminum stock Alcoa (AA[3]), fallen tech giant Hewlett-Packard (HPQ[4]) and troubled financial stock Bank of America (BAC[5]) and replacing them with some fresh faces.

Those watching the Dow might think that those laggards kicked out of the index are the worst blue chips Wall Street has to offer right now. However, a closer look at the Dow reveals five rather ugly components that still are holding back the index — and that investors should avoid if they want to profit in 2014.

The dogs of the Dow you should sell right now include Caterpillar (CAT[6]), Walmart (WMT[7]), IBM (IBM[8]), Coca-Cola (KO[9]) and Exxon Mobil (XOM[10]).

Here’s why these are all big-time stocks to sell:

Caterpillar

[11]Heavy equipment manufacturer Caterpillar (CAT[6]) looks like a safe bet on the surface. It yields almost 2.9% and has more than $65 billion in annual revenue.

But CAT is far from a good investment right now as the global growth outlook continues to be grim, particularly in the manufacturing-heavy economy of China.

Shares are off about 7% year-to-date, sparked in large part by three consecutive earnings misses. In January, it was a big writedown thanks to fraud at a Chinese company[12] it acquired, in April it was an earnings miss and disappointing guidance[13], then in July it was an ugly 43% slump in profits[14].

I’ll give you one guess as to how earnings will go in a few weeks, then …

The global mining boom in the wake of the financial crisis helped power Caterpillar shares a few years ago, but the subsequent commodity crash thanks to a slowing China has made those mining sales dry up. And like it or not, commodity stocks and related businesses like Caterpillar have been left out of the rally in 2013 … and could continue to sit out for a while longer.

Exxon Mobil

[15]Exxon Mobil (XOM[10]) is another battered giant that has seen earnings and revenue fade.

Despite XOM being one of the biggest oil stocks in the world, with a market capitalization of almost $380 billion and operating cash flow north of $56 billion annually, it looks like one of the shakiest investments on Wall Street. Exxon stock is down about 1% year-to-date despite a broad rally for the market in general.

Oddly enough, it’s not crude oil prices that are the problem for this energy stock, with prices pretty stable above $100 a barrel. The real culprit is profits, with earnings per share at XOM set to decline to the lowest level since 2010 this fiscal year.

Furthermore, the top line has declined year-over-year in five consecutive quarters, so it’s revenue that’s at issue as well as profitability.

Bulls are quick to point out that Exxon stock pays a nice 2.9% dividend — and at about 33% of earnings, there’s plenty of room for that dividend to grow even if profits don’t pick up substantially.

But it’s hard to fight against this kind of big negativity, or the fact that other stocks like Chevron (CVX[16]) or U.K.-based BP (BP[17]) look like better bargains based on forward earnings projections and current valuations.

IBM

[18]In July, IBM (IBM[8]) reported earnings that appeared pretty solid and beat expectations. But the details showed signs of concern for investors[19], and coupled with an ugly report in the preceding quarter, it looks like the future isn’t all that rosy for Big Blue.

A falloff in IBM’s hardware business weighed on both profits and revenue in April, sparking a quick 12% decline in about a week around its last report. However, shares recovered, which might have led some to write off that quarter as simply an outlier.

But it was software sales that led to a sigh of relief on Wall Street in July, not a hardware recovery. IBM earnings details revealed its Systems and Technology segment saw revenue down 12% year-over-year, prompting management itself to call hardware sales “mixed” on the quarter.

Expect more nastiness when IBM reports in the next week or two.

To be clear, it’s not just IBM swimming upstream right now. Enterprise spending has been tough for everyone from Accenture (ACN[20]) to Oracle (ORCL[21]), and the current government shutdown and looming debt ceiling debacle aren’t making businesses any more eager to spend big in Q4.

But any place you place the blame, it’s still a bad outlook for IBM in the months ahead.

Walmart

[22]Walmart (WMT[7]) is the world’s biggest retailer, and certainly has scale and a degree of stability from that reach.

But stability is not growth — and if investors can get a comparable dividend elsewhere, why mess with Walmart before what is sure to be another bad earnings report?

In its May earnings report, Walmart U.S. saw same-store sales slip[23] for the first time in almost two years — an uncomfortable reminder of the bleak run from 2009 to 2011 that featured an ugly streak of nine consecutive quarters[24] of same-store sales declines.

WMT repeated that performance with an earnings miss in July and continued declines in same-store sales — and a lowered outlook to boot[25].

The stock has underperformed in 2013 with 6% returns year-to-date, including an 8% decline since that ugly August report.

Don’t expect a turnaround when WMT reports in November.

Coca-Cola

[26]Coca-Cola (KO[9]), like Walmart, has a powerful brand and an enormous reach. It also has a nice 2.8% dividend yield.

However, just like WMT, Coke stock also shares some unfortunate truths that can’t be overcome by its massive brand appeal. It has underperformed in 2013, with just 3% returns, and is down by almost 15% from its 52-week high above $43 in May.

Coke investors seemed to buy excuses about wet weather sapping sales[27] in the spring, but another quarterly report full of disappointment rattled the stock this summer and really sparked declines.

The bottom line is that KO doesn’t have a lot of avenues for growth, and its legacy markets are mature at best and fading at worst. Consider that North American sales slipped this year — the first time in 13 quarters they had done so — as soda consumption continues to dry up amid a focus on healthier eating in the U.S.

A strong dollar also tends to weigh on Coca-Cola, with the currency’s relative strength estimated to shave 4% of the multinational’s operating profit this fiscal year.

The dividend is nice, and so is having Warren Buffett and Berkshire Hathaway (BRK.B[28]) as a main holder of Coke stock. But that’s not enough to deliver profits in the next few months as this soda giant fights serious headwinds.

Jeff Reeves[29] is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks.[30] As of this writing, he did not hold a position in any of the aforementioned securities. Write him at editor@investorplace.com[31] or follow him on Twitter via @JeffReevesIP[32]. 

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