Despite first-quarter growth slightly below expectations, I
recently encouraged investors to relax and enjoy themarket for at
least anotheryear until we see any real weakness instock prices.
I still think we have another year or two until the next great
collapse, but I've found one particular group ofstocks that may
soon be on its way down.
Prices have surged for this group, and investors are paying a
premium of up to 50% for these companies'earnings . Even as the
rest of the market continues upward, the bubble in these stocks
is already starting to deflate.
What's worse, this might be the last sector you would think would
be prone to a bubble.
To be fair, there is alot to like about the group. On average,
companies in this sector have returned 68.4% during the past five
years -- more than double the 28.7% return in the S&P 500.
The group also pays an average annualdividend of 3%, well above
the rest of the market.
If you haven't guessed, I'm talking about theconsumer staples
So what's not to like?
A Lesson In Bubble-nomics
The past five years have seen a dramatic shift for stocks of
dividend-paying companies in the consumer staples sector. With
fairly stable but lowrevenue growth and high payout ratios, these
companies were usually thought of as a highly defensive sector.
Because of these companies' relatively dim prospects for growth,
the prices that investors have been willing to pay for earnings
have usually been lower than those forgrowth stocks , such as in
the technology or consumer discretionary sectors.
This has changed with investors' fears of boom-and-bustmarket
cycles . Scarred by two market bubbles in the past 13 years,
investors are getting back into stocks by piling into the
historically safest plays first. The huge inflow ofmoney has
driven price multiples skyward, but investors rationalize the
hefty prices by looking backward at stable revenue growth.
The reasoning goes that earningswill eventually catch up to the
share price, and investors will collect a reliable dividend in
the meantime. As with most bubbles, this line of reasoning will
be revealed as obviously (and painfully) flawed when the market
realizes that future growth does not justify the lofty prices.
Although earnings for the companies that supply food staples and
household products should continue to increase, do we really need
another lesson in prices getting ahead of earnings? The fact that
Cisco (Nasdaq: CSCO)
continued to increase earnings and lead its industry in
innovation did not save it from falling 94% in the tech crash.
Valuation matters, and no group is immune to a herd-induced
Case in point:
was trading at a whopping 30 times trailing earnings compared
with an average of 19 times over the past five years.Shares
jumped 17.8% over the past year to its most recent earnings
report, more than twice the annualgain of 7% in the 15
year-period ending in 2005.
Why have the shares surged? Did the business fundamentally
change, or did earnings growth jump to drive the stock higher?
Neither. The jump in shares was purely a function of risk-averse
investors piling in for a 4.8% dividend from a company that will
outlive us all.
AT&T is a good company, but good companies can be lousy
stocks when their shares have been bid up too high. Last month,
AT&T posted a 5% drop -- its biggest one-day loss in four
years -- when it reported that its first-quartersales missed
The consumer staples sector is now the most expensive of all nine
tracked by Standard & Poor's Sector
Consumer Staples Select SectorSPDR (
sells for 17.1 times 2013 earnings estimates, compared with just
12.9 times for financials and 14.2 times for the S&P 500.
Earnings reports seem to have been the tipping point for many of
these stocks as investors realize the growth is just not there
tosupport these high prices.
These three household names are due to report earnings in the
next few weeks:
H.J. Heinz (
, whose shares have jumped by nearly 40% over the past year, is
due to report earnings May 27. Shares received a boost in
February when the company agreed to a $28 billionbuyout
fromWarren Buffett 's
Berkshire Hathaway (NYSE: BRKA)
and 3GCapital . A share price 23.6 times the past fourquarters '
earnings is more than 50% above the 15.6 average over the past
five years.Earnings per share (EPS) is projected at $3.56 for
2013 -- an increase of 6.3% over last year but not enough to
justify the lofty stock price.
Hormel Foods (
is set to report earnings May 23 after a nearly 45% jump over the
past year that has pushed its price to 22.6 times trailing
earnings. Thatprice multiple is 45% higher than what investors
have paid for the shares over the past five years.
J.M. Smucker (
reports June 1 and is trading at a 30% premium to its historical
price-earnings ratio after a 35% increase over the past year.
Investors frustrated at the meager 5.8% annualgains in the shares
over the longterm have been rewarded over the past year, but they
may want to cover their positions going into the earnings
The table below shows the performance of the three stocks over
the past year compared with theircompound annual growth rates
from 1990 to 2005. All three stocks trade significantly higher
than their five-year average price-to-earnings (P/E ) ratios.
These companies pay out a significant amount of earnings as
dividends, and the slow rate of revenue growth over the past five
years limits growth in future earnings.
*Long-run P/E average found by averaging high/lowTTM for
each of past five years, then taking average of five
Risks to Consider:
If anything emerges to knock the market back from itsbull
trend, then these stocks could continue to do well as defensive
plays. Even in that scenario, these shares have risen far beyond
what their fundamental growth justifies, and investors could
eventually pay the price.
Action to Take -->
Many of these stocks are long-term holdings in a diversified
portfolio and bring in a respectable dividend, making the
decision to sell difficult. At minimum, investors may want to
take profits on a portion of their holdings without completely
selling out of a stock. In any event, investors should exercise
caution and watch the valuation in shares.
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