There are value stocks, and then there are value traps. The former you want to own; the latter … well, obviously, not so much.
How do you tell the difference? Well, that’s a great question — and it’s one that value investors have been grappling with since Ben Graham invented this style of investing almost 90 years ago.
Sure, you can apply all sorts of financial valuation metrics such as price-to-cash flow when looking at a particular stock, but sometimes the answer isn’t so obvious. As Warren Buffett once said, “Price is what you pay, value is what you get.”
Take Nvidia Corporation (NASDAQ:NVDA), the technology company that revolutionized computing. Its stock delivered a total return of 225% in 2016, making it the best-performing stock in the S&P 500. By the way: That came on the heels of a 66% total return in 2015, 27% in 2014 and 33% in 2013.
Today, Nvidia’s price-to-sales ratio is 10.4 — 5.5 times greater than where it was at the end of 2012. So NVDA is a value trap, right? Maybe … maybe not. Analysts continue to up its target price, suggesting its impressive run over the past four years isn’t over just yet.
So, what are 10 of the worst values on Wall Street? Read on and I’ll tell you.
10 of the Worst Values on Wall Street: Caterpillar (CAT)
The election of Donald Trump has created a cottage industry of experts (myself included) who have been kept busy pinpointing the winners and losers among publicly traded stocks once the former star of The Apprentice takes office.
At the top of the list are infrastructure stocks such as Caterpillar Inc. (NYSE:CAT), whose big earth-moving machines will be vital to the work Trump intends Americans to do to make America great again.
It’s a quaint idea, but equally compelling is the argument that Trump’s anti-globalization, pro-isolationist movement will hurt many of the large-cap stocks that Trump expects to create jobs by reducing demand overseas for American products.
CAT stock gained 41% in 2016, including a huge post-election push, so that bubble appears ready to burst. Caterpillar’s quarterly revenues have been on a downward spiral since the beginning of 2012 with eight consecutive quarters of year-over-year declines. Its management recently warned that Wall Street was too optimistic about its fiscal 2017 earnings.
Meanwhile, shares sport a forward price-to-earnings ratio of 29.4 and a price/earnings-to-growth ratio of 13.2. No wonder Macquarie Research analyst Sameer Rathod has an “Underperform” rating on CAT stock and a 12-month target price of $58.50 — some 37% lower.
The Big Cat is just too darn expensive.
10 of the Worst Values on Wall Street: Netflix (NFLX)
Over the past 11 years, Netflix, Inc. (NASDAQ:NFLX) has delivered triple-digit annual total returns on three occasions: 2010, 2013 and 2015. On a 10-year basis, it’s generated an annualized total return of 42%. So considering NFLX was up just 8% in 2016, it’s easy to think another 100%-plus performance is due from the video streaming service in 2017.
Netflix stock continues to go higher despite its anemic profitability because investors are betting someone strategic like Walt Disney Co (NYSE:DIS) will acquire it for mucho dinero. I’d be shocked if Netflix is still a public company come 2019.
But just because I think that’s what’s keeping a floor below NFLX stock doesn’t mean Netflix isn’t one of the 10 worst values on Wall Street.
By every valuation metric, Netflix is more expensive than Amazon. And when you consider that Netflix doesn’t have a cash flow machine like Amazon Web Services, it’s pretty obvious that NFLX doesn’t provide good value.
10 of the Worst Values on Wall Street: Paccar (PCAR)
Truck-related stocks had a strong year in 2016, and no one benefited more than truck-maker Paccar Inc (NASDAQ:PCAR), whose 38% total return was its best annual performance since 2010.
However, analysts seem to be divided about the direction of PCAR stock from here.
Baird, for instance, just downgraded Paccar’s stock to “Neutral” from “Outperform” on the basis that it’s overvalued versus the rest of the market. In 2016, PCAR outperformed the index by more than 25 percentage points.
Investors might have bought PCAR stock in the final quarter of the year due to its 60-cent special cash dividend, but it latest quarterly report was anything but promising. Revenue and net income were down 12.3% and 20.8%, respectively, thanks in large part to lower truck sales in Canada and the U.S., along with a 60-basis-point decline in its gross margins.
Tack on an earnings yield of 2.5% compared to 4.4% for Oshkosh Corp (NYSE:OSK), and investors can definitely do better elsewhere.
10 of the Worst Values on Wall Street: JPMorgan Chase (JPM)
With the exception of energy stocks, financials were the best performing S&P 500 sector in 2016, up 20.1% — double the capital appreciation (dividends excluded) of the index itself.
There were no less than 26 financial stocks with 30% returns over the past year — a big sign that stock prices in this sector have probably got ahead of themselves.
But which one is the worst value on Wall Street?
Call me crazy, but I’m going with JPMorgan Chase & Co. (NYSE:JPM), whose shareholders were on the receiving end of a 33.5% total return in 2016, which is almost 20 percentage points higher than its global peers and Jamie Dimon’s fifth consecutive year delivering a positive total return.
However, when you consider that most global banks on a price-to-sales basis are cheaper than JPM, I would have real concerns about buying its stock at these prices.
By almost every valuation metric, JPMorgan Chase is more expensive today than it has been over the past five years.
10 of the Worst Values on Wall Street: Intuitive Surgical (ISRG)
I’ve read a bunch of material on the subject of the Republicans getting rid of the Affordable Care Act, and I tend to believe the argument that suggests hospital providers stand to lose the most if Obamacare is repealed. That’s because 20 million people who were covered under Obama won’t be covered under Trump, and that will result in emergency rooms becoming primary care facilities — and less profitable as a result.
Under that scenario, a company like Intuitive Surgical, Inc. (NASDAQ:ISRG), which had a 16% total return in 2016 — its third consecutive year of positive returns and fourth in the last five — will have a much harder time convincing hospitals that they should buy the company’s da Vinci surgical systems at $2 million a pop.
None of this will happen in 2017, mind you, but when you consider ISRG stock is trading at 25 times cash flow, or more than double the P/CF multiple of the index itself, a business tied to hospitals likely to suffer under Trump is just bad value.
That said, there’s no denying Intuitive Surgical’s success. If ISRG’s valuation on a price-to-cash flow basis were to drop into the teens, I might be convinced to change my opinion.
10 of the Worst Values on Wall Street: Nvidia (NVDA)
Yes, Nvidia Corporation (NASDAQ:NVDA) did, in fact, make the list. That doesn’t make it a bad stock, but it does make it a big risk.
Founder and CEO Jen-Hsun Huang was a keynote speaker Jan. 4 at the Consumer Electronics Show in Las Vegas. The buzz following his company’s stock is electric. Prior to his speech, Raymond James analyst Steven Smigle came out with a reiteration of its “Strong Buy” rating, upping NVDA’s target price almost 40% to $125.
Smigle is a big fan.
“Given consistent growth, profitability, and more than $7/share in cash, we continue to believe Nvidia represents a unique long-term secular growth story with a leading position in key verticals — and no signs of slowing momentum,” he wrote in a note to clients.
I get where Smigle is coming from; Nvidia is firmly in the momentum camp whether we’re talking about its stock or its business. Under no circumstances could you consider NVDA a value stock or even a growth-at-a-reasonable-price (GARP) stock.
Nvidia has had a good run, and maybe it will continue to climb in 2017. But from where I sit, a forward P/E of 33.6 and a PEG payback of 12 years both seem to scream bad value.
Is it one of the 10 worst values on Wall Street? Well, maybe not if you’re considering all 3,812 stocks in the Wilshire 5000. But it’s certainly among the worst values in the S&P 500.
10 of the Worst Values on Wall Street: Oneok (OKE)
In 2016, Oneok, Inc. (NYSE:OKE) blew the roof off its stock price, generating a total return of nearly 143%. That’s a pretty nice turnaround from the previous year, in which shareholders saw a decline of more than 45%.
Back in July 2016, Contrarian Outlook’s Brett Owens suggested that investors sell OKE stock because the Oklahoma natural gas pipeline company’s stock price had gained too much since the beginning of the year, making its dividend yield less attractive and its P/E ratio of 36 unappealing given its earnings growth rate.
Since then, OKE stock has tacked on another 25% or so, finishing 2016 with a tremendous triple-digit total return.
Yes, it seems silly to say, but Owens wasn’t wrong — he was just early.
OKE’s dividend yield is down to 4.2%, and its earnings yield is even lower at 2.3%. I don’t know about you, but generally, I wouldn’t want to own this kind of stock unless its earnings yield was less than its dividend yield.
To me, there’s just no value here.
10 of the Worst Values on Wall Street: Ulta Salon (ULTA)
Sector: Consumer Discretionary
What a run Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) stock has been on.
In 2016, ULTA stock achieved an annual total return of 38% — the third year in a row with positive returns. Over the past five years, Ulta Salon has averaged an annual total return of 32%, which is more than double the S&P 500.
I’m of two minds when it comes to ULTA stock.
On the one hand, I believe its stock price is (and has been for some time) ready for a correction. Indeed, it had a mini-correction in the fall when ULTA dropped all the way down to $228 by early November — a 12.7% decline from my July 29 article where I suggested a 20% correction was possible but unlikely given its momentum. Since then, it has gained all that back.
On the other hand, Ulta Salon has a great business model with no debt and double-digit same-store sales growth. For now, it’s the belle of the ball.
Still, at 30 times cash flow, you can’t mistake ULTA for a value stock. It’s clearly not.
10 of the Worst Values on Wall Street: Marriott (MAR)
Sector: Consumer Discretionary
Hotel stocks generally had a good 2016, finishing 13.8% higher — 180 basis points better than the S&P 500. Of the three lodging stocks in the index, Marriott International Inc (NYSE:MAR) was easily the best performer with a total annual return of 25%.
In recent years, as Marriott moved to an asset-light business model, spun off its vacation ownership unit and acquired Starwood Hotels, its stock has really flourished.
However, with new supply coming on stream at an accelerated pace in 2017 and 2018, hotel operators are not going to be able to raise room rates nearly as easily as they have in the past couple of years.
Thus, given revenue growth is likely to slow, which will put pressure on profits, its current earnings yield of 3.4% (and P/E of 29) seems high. In addition, dividend investors shouldn’t be too excited about a 1.5% yield.
Marriott is certainly on the borderline of the worst values on Wall Street — you can probably make a case for a few other stocks making this list over MAR. But for 2017, with the ongoing integration of Starwood taking up much of management’s time, it’s hard to imagine Marriott stock coming anywhere close to its performance of the past year.
10 of the Worst Values on Wall Street: Freeport-McMoRan (FCX)
Sector: Basic Materials
Freeport-McMoRan Inc (NYSE:FCX) had a fantastic 2016, delivering a total shareholder return of 94.8% in 2016 — its first year of positive returns since 2013.
Driving FCX higher were rising copper prices that had faced downward pressure for the better part of five years. That was until November 2016, when it pierced $6,000 per metric ton on news of lower supply, greater demand for the base metal in China, and Donald Trump’s move to increase infrastructure spending in 2017 and beyond.
Unfortunately, the gain in copper prices experienced in the latter part of 2016 is likely to retreat as new information comes to light suggesting both supply issues and China’s surging demand were both overblown.
FCX trades at 5.4 times cash flow, or about 30% higher than its five-year average. Thus, any bad news regarding copper will likely send shares back down near $10, where they traded prior to the October 2016 sprint to the finish line.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.