3 Megacap Blue Chips You Don’t Want to Buy

by Jeff Reeves | February 26, 2014 1:47 pm

There’s a lot to be said for investing with an eye to low-risk, megacap blue chips that pay a reliable dividend and don’t suffer that much price fluctuation.

But the problem with some of these lumbering blue-chip stocks isn’t just that they don’t offer much in the way of excitement or breakout potential … it’s that a lot of these blue chips are also showing a recent history of big underperformance.

These fallen giants lag with share appreciation, they offer below-average dividend potential and they still carry the risk of a capital loss even if they have no hope of breaking out.

It’s sometimes sacrilegious to talk about ditching these “widow and orphan” investments that many investors consider buying and holding forever. And I’ll admit that if you’re holding any of these stocks with a very low cost basis and are simply collecting a juicy dividend, then go right ahead holding.

But if you’re looking for the best place to put new money going forward, these fallen giants should certainly not be on your list.

Here are three megacap stocks to sell now: Exxon Mobil (XOM[1]), McDonald’s (MCD[2]) and Coca-Cola (KO[3]).

Blue Chips to Pass On: Exxon Mobil (XOM)

Some folks have always considered Exxon Mobil (XOM[1]) the ultimate buy-and-hold investment because it’s one of the largest companies in the world. And it’s highly unlikely XOM is going anywhere considering:

• It’s valued at over $420 billion in market cap, making it the second-largest U.S. stock by this metric behind Apple (AAPL[4]).
• It’s at the top of a capital-intensive energy exploration industry, where regulation and barriers to entry are high.
• It is one of four companies — along with ADP (ADP[5]), Microsoft (MSFT[6]) and Johnson & Johnson (JNJ[7]) — that boast the ultimate AAA credit rating for its debt. It also sits on $5.3 billion in cash and another $37 billion in long-term investments to boot.
• Exxon has paid dividends since 1882 and has increased its payouts once a year dating back 31 years.

Sounds like a lock for any long-term portfolio, right?

Well, the issue with XOM stock is that while energy consumption is growing in some emerging markets, efficiencies in the West have resulted in flatlining or even dropping demand. Consider that oil consumption in the U.S. recently fell to a 16-year low[8] as just one data point of note.

Consequently, XOM has seen its stock basically go nowhere since 2008.

But even more troubling is Exxon’s payout of dividends. While its dividend growth has been consistent and substantive — with payouts up 133% from 27 cents a quarter in 2004 to 63 cents quarterly currently — its dividend payout rate is anemic. The company is forecast to make about $8.20 per share in FY2014 earnings but pay out $2.52 in dividends for a miserly 30% payout ratio.

You can argue that makes dividends sustainable, but at a headline yield of just 2.6%, Exxon is paying less than 10-year Treasury notes.

If you bought XOM stock a decade ago and have a great cost basis, there’s reason to hang on. But why throw new money at this cheap dividend payer when overall energy demand remains pressured and shares have been sluggish for several years now?

Blue Chips to Pass On: McDonald’s (MCD)

McDonald’s

(MCD[2]) is one of those companies that stands for American businesses that go global. MCD is ubiquitous, not just here in the U.S., but also as a brand around the rest of the world.

But the massive growth and reach of MCD is not actually a virtue anymore to investors. With about 35,000 locations in 120 countries there is not only a problem in finding new and profitable locations, but a serious problem in adding up enough new sites to significantly move the needle for MCD stock holders.

And let’s not forget that McDonald’s also remains the poster child for unhealthy eating, and that a focus on health and fresh ingredients at home and abroad could harm sales long-term. For some consumers, MCD will remain a purveyor of processed beef and greasy fries no matter how many healthy items the restaurant puts on the menu to change its image.

Case in point: Recent trouble with the top line that shows how hard it is to generate significant revenue growth for this entrenched fast food company. From fiscal 2011 to 2012, revenue grew just 2% or so, from a bit over $27 billion to just shy of $27.6 billion, according to S&P Capital IQ. Then from 2012 to 2013, revenue grew by that same meager 2%.

Across 2014? More of the same, with low single-digit growth predicted by analysts.

Now, MCD has been working to juice revenue through efficiencies and stock buybacks. The company has repurchased between $2.5 billion and $4 billion[9] in stock annually since 2007, and is operating under a $10 billion buyback plan[10] approved in 2012. But shareholders need to realize that it’s these buybacks fueling modest increases in earnings … not sales.

Now, MCD has a good history of dividend growth with payments that have soared 470% in 10 years to the $3.12 paid out all of last year. But the payout ratio is already more than half of 2014 earnings, so it’s unlikely that aggressive dividend growth will continue given the serious challenges to earnings and revenue growth.

If you own McDonald’s and have a great yield because your cost basis is around $30 or $40, good for you. But new money will get a 3.3% yield with little dividend growth in their future.

Blue Chips to Pass On: Coca-Cola (KO)

Much like McDonald’s, Coca-Cola (KO[3]) is a company that is synonymous with globalization and American consumerism.

But also like MCD, Coca-Cola faces serious challenges thanks to market saturation and changing consumer tastes.

KO revenues grew just 3% from 2011 to 2012 and actually declined from 2012 to 2013. Analysts are predicting a return to revenue expansion in 2014, but Coca-Cola is looking at low-single-digit growth at best.

Why? Well, Coca-Cola is quite literally almost everywhere with 500 brands in 200 countries. It’s actually easier to list the places Coke is not a player[11] then where it has a footprint. That’s good for stability, but short of space exploration shows that Coca-Cola is very limited when it comes to opening new markets.

Sure, Coke could branch out into new products as it looks to do with a recent partnership[12] with Green Mountain (GMCR[13]) of Keurig coffee maker fame. However, even if Coca-Cola does branch out into in-home beverage gadgets, it will take a whole heck of a lot to move the needle for a $165 billion company with almost $50 billion in annual revenue.

Throw in the fight against sugary soft drinks, and there’s a pressing need to figure out the next step for Coca-Cola. After all, its branding is completely tied up in its namesake drink … which remains in the crosshairs as sodas become unpopular among health-minded Americans.

Now, Warren Buffett has held KO stock for decades and there’s clearly a benefit to hanging on if you have been a longtime shareholder. But for new money, don’t bother.

The 3.2% yield at current pricing is nice, but Coke is already paying out more than half of earnings via dividends. KO bumped its quarterly payment a mere 10% in each of the last two years, so investors better be patient if they expect any significant dividend growth.

And considering Coke is up a measly 20% or so in the last 15 years, investors shouldn’t expect much on the share appreciation side, either.

Jeff Reeves[14] is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks.[15] As of this writing, he did not hold a position in any of the aforementioned securities. Write him at editor@investorplace.com[16] or follow him on Twitter via @JeffReevesIP[17]. 

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