The search for yield has been the overriding theme for the past several years for individual investors. Many have taken the path of buying blue-chip stocks with the idea of holding them and collecting the dividends and then magically selling just before a market correction.
Some say they are content to hold them forever, and while that’s not a horrid strategy, I have met very few people with the fortitude to hold any stock through environments like the dot-come bubble or the financial crisis.
All too often, investors finally get too scared and sell out very near the bottom. So, rather than pretending that you’re going to hold your blue chips forever, it’s much better to identify which ones are overvalued before the rest of the market starts punishing them for it.
Six years into the bull market, buying and holding blue chips at the current extended valuations may not be the best idea for most investors. Here are three overvalued blue chips you should consider dumping.
Overvalued Blue Chips: Coca-Cola (KO)
At a minimum, investors should be alert to exactly how the blue chips they buy are valued. While its true that Coca-Cola (KO) may indeed be around forever, that doesn’t meant the stock is safe at any price.
Investors who buy KO because they drink a bunch of Diet Coke every day and the stock yields 3% may not realize they are paying 25 times earnings for a company that will be lucky to grow by 5% a year going forward. Like other blue chips, the valuation of Coca-Cola is dependent almost entirely on interest rates staying low.
If the stock were to fall to $30 per share, KO would be valued at a much more reasonable multiple of 15 times earnings for a low-growth company. Coke is a great company with good products, but there are few growth opportunities for a company this size, and the beverage marketplace grows more competitive every year.
Overvalued Blue Chips: Pfizer (PFE)
The same scenario applies to many blue-chip pharmaceutical companies that have always been thought of as dividend darlings that were best bought and held forever.
Pfizer has long been a favorite among income stocks, and back in 2009 when the world was ending and the stock traded right around book value with a price-to-earnings ratio of 12, I was an enthusiastic buyer of the blue chip drug company.
Today, however, the company is trading at more than triple its book value, with a P/E ratio of 24.
Wall Street analysts as a rule are the most optimistic folks on the planet, and they think the company will grow by less than 4% annually for the next 5 years or so. This is not a case of Pfizer being a bad company. Quite the contrary — it’s an excellent company, but it’s simply too expensive to buy at these prices.
Overvalued Blue Chips: Kellogg (K)
Kellogg (K) is one of the most highly regarded companies in the world. It dominates the breakfast cereal market place and has done so for most of my lifetime.
The company has been around since 1906 and is the epitome of a blue-chip stock. K stock yields a respectable 3.2%, but is also trading at about 50 times earnings at the current price. The company is only expected to grow revenues by about 3% annually for the next five years.
Meanwhile, the stock is flirting with an all-time high as yield seeking investors ignore the stagnant sales environment and focus on the dividend yield. If rates begin to rise in the next few years, we could see multiple contraction that shaves a huge fraction off the stock price.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities. He is the author of the Banking on Profits newsletter covering the community bank stock opportunity and the Deep Value Report that seeks out undervalued stocks that are likely to survive until they thrive and capture the value effect that has been proven to beat the market over time.
