Sell now: These prices don’t make any sense

 

You will have noticed by now that those who talk stock often talk of valuations, such as the price to earnings ratio, or P/E. Countless studies have shown that the public is mostly unimpressed / bored by this, so you may wonder we continue to do it. We look at P/E because doing so is an essential step in the process of translating our insights, guesses, and assumptions about stocks into numbers. As a means of gauging a stock’s value, P/E is imperfect even at the best of times, particularly in absolute terms, since it is a measure of how much we are paying for what a company earns based on the price of its stock, and there is no means of computing any theoretically best amount for that.

Despite that, P/E works pretty well for comparative purposes, and that is how I use it now; by comparing the current average P/E of S&P 500 stocks to past average P/Es of S&P 500 stocks, it is possible to gauge the market’s overall confidence. What we find, given an average P/E of just over 24, is that stock buyers believe earnings are likely to be increasing across the board and stock prices rising for years and years to come, probably at a somewhat faster rate than they have been rising for the past seven years.

The problem is that no one actually believe that. Prices are being driven not by value, but by fear of missing out. I’ve assembled a list for today of what I believe are the worst offenders.

Remember to treat these ideas as just that, ideas, and do your own research before making any investment decision.

Best Buy (BBY)

Here is Mr. Julian’s law: every form of retail that can be replaced by online retail eventually will be. I hold this truth to be indisputable, but every so often, for a time, particular retail chains defy the trend. The chain in question today is the $21 billion electronics store, Best Buy. Like a salmon leaping up a waterfall, Best Buy has made tremendous forward progress against a powerful current. From $51.81 at this time last year, shares of BBY have risen to $75.62. In early March, Best Buy’s CEO announced that it had completed its corporate turnaround and now had room to compete with Amazon.com head to head.

Strong words, but it can’t last. Over the past year, Best Buy has been able to compete with Amazon on price, but the necessarily higher overhead of maintaining showrooms and staff mean this can’t last long, especially considering that Amazon.com, flush with profits for the first time ever, has all the room in the world to push its prices lower. Add in the large number of other retailers who now sell electronics and who are desperately fighting over the scraps from Amazon’s table, and you’ll see what I see: a fantastic opportunity to get out of this stock. Don’t forget that only a few days after defying gravity, salmon die.

Chart courtesy of www.stockcharts.com

Anheuser-Busch InBev (BUD)

Many articles suggest that the good old days of beer are finally on their way back in, and that the slow rise of craft beer has finally stalled for good. Others see this as a mere blip in the numbers, a view I’m inclined to agree with, as no one has offered any compelling reason why Americans should now begin to hold more stubbornly to “traditional” tasting brews rather than switch over to “palatable” ones, but I have my own theory: simple psychological regression.

In times of stress, we fall back to earlier emotional states and habitual behaviors, thus flooding our brain with sensations it associates with the good old days. Such regressions don’t go on forever, and neither will the uptick in consumption of horrific tasting beer, for the simple reason that they don’t work. Budweiser and Miller drinkers may not like the way the world is changing, but given sufficient time, they will realize they can’t change it back by drinking horrible (I mean traditional) tasting beer. Woe to holders of BUD shares on that day.

Chart courtesy of www.stockcharts.com

Royal Bank of Canada (RY)

The problem facing Canada’s banks could not be simpler in outline. They have taken on too much mortgage risk at a time when it now appears that its customers were buying on the wave of a speculative bubble. Prices peaked in January and fell precipitously in February. They were flat in March, but that doesn’t mean they are done falling. If they were to start falling again it would mean bad news, particularly as interest rates are now rising, compounding the risk of default. Even if Canadian banks escape the (as we know from 2008) very real possibility of a meltdown, they’ll probably be stuck with too much mortgage debt for their liking in a higher interest rate environment, and since everyone is in the same boat, no one is likely to take it off their hands.

Chart courtesy of www.stockcharts.com

Trans-Canada (TRP)

You may have heard about the Keystone XL Pipeline, a controversial project in which many companies have played a part, but which is now owned solely by Trans-Canada. The company’s license to build Keystone XL was rescinded under President Obama but reissued under President Trump. Unfortunately for Trans-Canada, the move is widely seen as part of an effort by President Trump to undo all things done by his predecessor. I argue that Trans-Canada is never going to be able to complete its pipeline while its legality is the subject of a Washington DC revert war, and that means they will never pump barrel one through it or recognize dollar one in revenue from it. On a longer scale, Trans-Canada is hosed because it sells mostly bitumen-heavy tar sands, the worst oil on Earth. You might say it’s the coal of oil. In any case, Trans-Canada will find itself quickly sidelined once the world begins to again pay attention to air quality, water quality, or even, for that matter, oil quality.

Chart courtesy of www.stockcharts.com

Mondelez (MDLZ)

Mondelez sells delicious sugary and salty snack products, all over the monde, as its grotesque portmanteau of a name implies. What the company has going for it is a relatively high operating margin of 14.6%. What it has going against it is annual organic revenue growth from sales of just over 1%. Nearly all the apparent growth here is from currency headwinds, acquisition, and share buybacks—Mondelez doesn’t even stand to benefit much from the Trump tax cut. Bottom line, this company sells poison, and as such, it is doomed. While the drums have fallen silent for now, America will get back on the warpath against the epidemic of obesity, assuming we aren’t all killed first by heroin and meth.

Chart courtesy of www.stockcharts.com

Symbols: BBY BUD MDLZ RY TRP
Julian Close

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

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