The recent rally in the stock market may have been great news for those who had gone bottom fishing earlier in the year, but it really was not so great for investors who have cash piled up and need to get it into income-producing stocks.
The last decade has been one of frustration and no small amount of anxiety as income investors have looked for a place to invest for income without taking on unreasonable risk.
One of the most frequently given pieces of advice is to look for dividend-paying blue-chips stocks, since these are the best-known companies in the world and you are unlikely to have default risk.
While there is a grain of truth in this, it is important to keep in mind that as Warren Buffett mentioned again in this year’s shareholder letter, even a business with terrific economics can be a bad investment if it is bought at too high a price.
Blue-Chip Stocks to Avoid: Merck & Co, Inc. (MRK)
Merck & Co, Inc. (MRK) is a great example of the too richly priced blue-chip stocks.
Merck is one of the biggest drug companies in the world and would appear to have enormous tailwinds from an aging population and new drug developments. However, the stock has traded higher almost continuously for the past six years as the market recovery and dividends seekers have pushed prices steadily higher.
Today the shares yield 3.53%, which seems attractive in light of low rates from fixed-income products. When we look deeper though, we find that even those unreasonably optimistic folks who make up the cadre of Wall Street analysts think the company can grow by just 4.7% annually over the next five years.
At today’s price, we are paying over 30 times earnings for shares of the drug company, and that is just too high. Even if MRK hits the aggressive earning targets for next year, the stock will be trading at about 3 times the tepid growth forecasts.
Merck may be a great company, but the stock is simply too expensive to consider.
Blue-Chip Stocks to Avoid: The Coca-Cola Co (KO)
The Coca-Cola Co (KO) is another example of a wonderful business that is just too expensive right now.
Coke is one of the most irreplaceable brands in the world today. While they have some competitors, ask yourself … when was the last time you hears someone walk into a bar and order a Jack and Pepsi (PEP)?
Investors who were brave enough and smart enough to buy the stock when the word was ending back in 2009 have not only enjoyed generous dividends but they have also seen the stock price rise steadily over the past six years.
Buyers today will probably not enjoy the same return, as the stock is currently priced at more than 25 times earnings in spite of a projected growth rate over the next five years of just 2.2%.
Coke is one of the greatest companies in the world but the price is just too high in spite of the 3.17% yield.
Blue-Chip Stocks to Avoid: General Electric Company (GE)
General Electric Company (GE) is another company that is one of the greatest success stories of business.
It has hard to think of a business GE is not in, as they have operations in energy, aviation, appliances, healthcare, information technology and finance.
Had you been brave enough to buy GE at the market bottom, you have done extraordinarily well as the stock has soared six fold and paid a steady stream of dividends.
Today you are paying 17 times the always-highly-accurate analyst estimates for next year’s earnings, which is twice the forecasted growth rate of 8.83%.
The stock is yielding 3.02% but the shares are simply too richly priced relative to the earnings growth that is expected. Should economic conditions not improve around the world, even that anemic growth rate could prove to be too high, so investors should avoid putting any new cash into shares of General Electric at current prices.
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.