When it comes right down to it, there are only two basic approaches to being an investor. The first one traditionally has been the more common one — trade stocks based on what they should be worth in the future. The second approach historically has been less-adopted — trade stocks based on what they are doing. About 80% of the time, those two approaches will end up in agreement on a stock-by-stock basis. It’s the other 20% of the time, however, that can kill your portfolio.
The past two months has been that “other 20%” of the time.
It’s been a bit of a problem all year long, but as of early August we saw a complete disconnect between the fundamentals and stock prices. Stocks of bad companies got crushed. Stocks of good companies got crushed. Valuations, present or future, were irrelevant.
You could make the argument that all that selling was in light of a looming recession that would eat into the profits of all companies no matter what business line they were in (despite forward-looking estimates). That’s an excessively apocalyptic viewpoint, though, as there were plenty of companies that had no problem sustaining and even growing earnings in 2008, even when things were their darkest.
Now, this normally is the point where a commentary would preach a “stay the course” sermon and remind its readers that “fundamentals always win in the end.” You’re not going to get that speech, though. In fact, you’re going to get the opposite.
As nice as it would be to think that stocks always eventually trade at what they’re worth, if they lose 30% en route to that valuation — and if they take three years to recover — then finding an undervalued company still does you no good. Perhaps John Maynard Keynes really did say it best with his oft-quoted quip, “The market can stay irrational a lot longer than you can stay solvent.” Or as yours truly puts it, the road to the poor house is paved with undervalued stocks that “should have gone higher.”
With that as the backdrop, here’s a look at three very fundamentally attractive companies with three very alarming charts — the kind of charts that leave you wondering just how bad things can get. They’re the kind of charts that have you double-checking the ticker and the underlying fundamentals, because something doesn’t quite add up.
H.J. Heinz Company
Click to EnlargeFor the first time in more than two years, H.J. Heinz Co. (NYSE:HNZ) shares are under all their key moving average lines — and apparently to stay for a while. Were it something we saw on a regular basis, we’d think little of it. When the market is running so scared that it thinks sales of ketchup are going to dry up, though — and sends the stock under major support levels — then it’s pretty clear the selling isn’t something that’s being done discriminately. It’s a tide just too big to bother fighting, even though H.J. Heinz is nothing but an earnings machine.
Ironically, it’s the reliable success of this stock that makes it so vulnerable right now. Owners have grown to see it as “old faithful,” and now that is isn’t, the selling flood gates could open.
Wells Fargo
Click to EnlargeTo be fair, there’s a last bastion of hope for Wells Fargo (NYSE:WFC). It’s the floor at $22.90, which has so far held this banking stock up for the past two months, much as it did in late 2010. That string of lower highs, though — not to mention the mere guilt-by-association with Bank of America — might end up being enough to push WFC over the edge.
The sad part? Wells Fargo & Company truly is rebuilding itself the right way and has been profitable again for quite some time, having not gotten neck-deep in bad mortgage loans in the first place (just waist deep). After a decided profit rebound in 2010, though, the stock’s a bargain at only nine times its trailing earnings and 18% earnings growth on tap for 2012.
The problem is, if nobody cares, then nobody cares.
UnitedHealth Group
Click to EnlargeJust for perspective, UnitedHealth Group (NYSE:UNH) has posted three straight years of top-line growth, and 2011 is on pace to be its fourth. It’s also been profitable — consistently — for years, and has been creating record-breaking profits since the middle of last year.
It’s an important footnote to explain first, before pointing out the plunge to $42.95 on Monday of this week — which happened to drag the stock under its critical 200-day moving average line. The culprit for the dip? News that the Supreme Court would be deciding the constitutionality of President Barack Obama’s health care plan sometime in the middle of 2012. The worry is that a repeal of the plan would crimp the expected profits the plan itself would generate for health care plan providers.
Superficially, the logic makes sense. Give it a couple of seconds’ worth of thought, though. UnitedHealth Group has been doing just fine without Obamacare — does it really need it that badly?
The most troubling part isn’t so much the dip, but the time frame associated with it. By delaying any decision for at least six months, the Supreme Court has given misguided investors a six-month window to beat the stock up despite the fact it’s already undervalued and poised to pump up the bottom line no matter what happens with Obama’s health care package. The company is jockeying to raise premiums by at least 13% in some states next year. Nevertheless, the sellers now have the bearish ball rolling.
The Last Word
A tough reality to accept when it goes against conventional wisdom? Maybe this will help:
Remember, as an investor, you’re not participating in a company’s success — you’re just renting their stocks, hoping the collective market sees them as more valuable in the future. That’s quite a leap of faith.
Disclosure: I have no positions in any of the stocks mentioned in this article.
