One of the most important aspects of investing is determining whether an underperforming stock is a true value opportunity or whether it’s struggling for a reason.
Right now, five blue-chip stocks stand out as recent laggards that should be given some more room to fall even further before investors hit the buy button.
These aren’t the “easy” stocks to avoid, like the JCPenneys (JCP) and RadioShacks (RSH) of the world. Instead, these are blue-chip stocks that might look attractive on the surface, but where the risks outweigh the potential returns.
The reasons range from the fundamental to the technical, but the common ground is the same: investors are better off looking for value plays elsewhere.
Blue-Chip Stocks to Avoid #1: Whole Foods (WFM)
Now, however, the growth story appears to be in jeopardy.
WFM’s last report featured revenues and earnings that came in below expectations, and the company lowered guidance for 2014. Whole Foods is facing increasing competition, which puts it in the difficult position of deciding whether to compete on price — with the associated hit to profit margins – or to hold the line on pricing and take the chance of weaker sales.
For this, investors still need to pay a premium multiple on WFM stock: 36.6 times trailing earnings and 28.7 times forward estimates. Whole Foods still is on track for better profit growth than the market as a whole, but investors need to pay through the nose to participate.
A scary technical picture accompanies this softening fundamental outlook. WFM stock has slipped below its 200-day moving average, and it has developed a triangle formation with support at $50. This is a negative setup that indicates WFM is in for a rockier road in 2014.
Put it together, and there’s no need to rush into Whole Foods here. Given the combination of a high valuation, fundamental headwinds and a questionable technical picture, investors should be able to pick up WFM stock at a better price before the year is out.
Blue-Chip Stocks to Avoid #2: AT&T (T)
The trouble is, there are no secrets with a stock like AT&T — and its yield reflects the rising competition and lack of growth prospects. After posting EPS of $2.50 in 2013, AT&T is expected to earn $2.65 this year and $2.78 in 2015.
Here, advocates will say that the dividend alone is reason enough to buy AT&T stock, that it’s a secure payout from a solid “bond proxy.” This might be true to some extent, but income investors are also taking on stock market risk in exchange for the yield. Just this year, AT&T shares have shed 6.2%, which has already more than erased the return from dividends.
Investors aren’t going to go broke in AT&T. However, the limited upside from a challenging competitive landscape means that the yield, while outstanding, doesn’t offset the potential principal risk. On this front, it’s worth noting that even as the S&P 500 has gained 24% in the past 12 months, AT&T stock has fallen about 6% (with dividends included).
Given AT&T’s track record in a roaring rally, investors need to question what will happen to the stock if the broader market encounters rougher going in the months ahead.
Blue-Chip Stocks to Avoid #3: BHP Billiton (BHP)
Click to Enlarge Anyone who has tried to position for a rebound in resource stocks knows the frustrating false dawns that have occurred in recent years.
BHP Billiton (BHP) is a prime example — after rising over 30% in the second half of 2012 (a move that took the stock above both longer-term trendlines and its 200-day moving average), BHP gave that all back, and more, in the first half of 2013. BHP stock has provided yet another head-fake this year, surging in early February before reversing course in the past two weeks.
BHP seems like a stock to buy and hold here — it has a reasonable valuation, a 3.6% yield, and it’s a contrarian play. The problem, of course, is China. Questions about economic growth and credit conditions in the nation continue to plague companies that do the bulk of their business in the country. China’s Purchasing Manager’s Index is sitting at an eight-month low and is hovering just above the 50 level. Even if the country doesn’t suffer a “hard landing,” there still are more shoes to drop with regard to China’s slowing growth — and that means high risk in BHP Billiton, low valuation or not.
Also, BHP stock is moving within range of the $55-$60 level that has served as support for the past five years. There’s still plenty of room before this support line is breached, but the odds are growing that such a breakdown will occur. Be patient with BHP stock — there should be plenty of opportunity for dip-buying before the year is out.
Blue-Chip Stocks to Avoid #4: Anheuser-Busch InBev (BUD)
Still, BUD stock remains on the wrong side of consumer trends. U.S. beer sales fell in 2013, with light beers taking the biggest hit while craft beers grabbed a bigger share of the pie. As discussed in detail in this 2013 article from The Atlantic, beer is losing ground relative to both wine and spirits in the United States, particularly among young people. Granted, BUD is a global company and still the world leader in market share — a plus given that beer consumption continues to rise worldwide. However, much of this growth is coming from China, where local beers are the dominant brands.
These trends are reflected in BUD stock’s slow growth and falling earnings estimates, but not its valuation: its shares fetch a hefty 17 times forward earnings estimates. In contrast, Molson Coors Brewing Company (TAP) is valued at 13.6 times estimates. Not only that, but BUD stock is more than twice as volatile as the overall consumer staples sector, indicating that investors have to take on excess risk for InBev’s modest return potential.
With shares bumping up against resistance in the $105 area, BUD stock is best avoided here.
Blue-Chip Stocks to Avoid #5: International Business Machines (IBM)
IBM (IBM) has been performing well of late — having gained nearly 7% since January — but it has gone nowhere since late 2011. Warren Buffett has given IBM a boost with his mild support, but check out his commentary on the stock from a CNBC interview on March 3:
“The revenue trends have been less than anticipated – although not dramatically less than anticipated. The financial performance has been pretty good but it’s been helped by low tax rates and things of those sort. There is a transition going on in the business, particularly in terms of the cloud. It’s fair to say that I know less about the future of IBM than I might know about the future of Wells Fargo or Coca-Cola or the [other] businesses we own. I think I do know enough it to still feel good about owning the stock.”
If this is the best Buffett can muster on a stock he feels good about, his commentary on the names he’s avoiding must be brutal.
The key point in Buffett’s quote regards IBM’s revenues. The company is expected to chalk up the following revenue numbers (in billions) during the three-year stretch from 2013 to 2015: $99.75, $99.30, $100.66. Earnings continue to rise, and investors can bet that CEO Virginia M. Rometty is going to make good on her promise to deliver $20 in EPS in 2015 — one way or the other. Still, the stock’s tepid performance of the past two-plus years shows that investors are growing impatient with relying on financial engineering with a company that seems to be in a perpetual state of transition.
Add it up, and there’s no reason to own IBM stock here — even at 9.4 times earnings.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.