When these stocks crash, it’s going to be too painful to watch


As the market rises ever higher, those of us who have been around for a cycle or two (or three) can’t help but feel an ominous sense of deja vu. We have all been enjoying, if not easy wins, then at least the sense that it is the market’s inevitable destiny to rise, and that all we really need do to ensure a happy outcome is stay invested and diversify. And maybe that’s true, for those who are willing to wait it out through a two, four, or six year-long market trough. I, for one, plan to be safe on the shore when this boat goes down.

Ah, but divesting decisions are as hard to make as investing decisions, and often even harder, as it is difficult not to form some emotional attachment to stocks that have made us a lot of money. So while I don’t recommend moving everything to cash, I highly recommend getting out of your most risky stocks, and holding that money for a time. Here are a few that look extremely risky to me. As always, remember to consider these ideas to be just that, ideas, and do your own research before making any move on the stock market.

Netflix (NFLX)

The last couple of quarterly reports from Netflix, especially the most recent, have painted a picture of a company that is growing far more slowly than it expected to grow, yet shares of NFLX are still trading at remarkable trailing P/E Ratio of 290. For those not familiar with P/E, let me briefly explain that the average P/E of S&P 500 companies is about 25. Rapidly growing companies, which, even now, Netflix remains, are generally expected to have high or very high P/Es, which is what Netflix’s P/E would be if it were roughly a third as high as it is now. As P/E is a ratio tied to price, this suggests that NFLX shares may still be overpriced by a factor of three, which in turn suggests that only a generous assessment puts its true value at half its current price.

It has often proven to be the case with the market’s fallen angels that investors, still wanting to believe, overlook unwelcome truths. In this case, the unwelcome truth is that Netflix is growing more slowly than it thought it would because it over-estimated the ultimate size of its potential market and has hit the flattening-out point of its growth curve sooner than anticipated.

If I’m even partly right about this, NFLX shareholders can look forward to a very painful day of reckoning.


Chart courtesy of www.stockcharts.com

Baidu (BIDU)

Baidu is one of the Chinese internet companies that exploded onto the investment scene in the first half of this decade. When these companies began to trade publicly on American markets, they offered the exciting prospect of a new land for the internet to conquer, and they appeared to offer a chance for a do-over to those who failed to grow wildly rich during the US internet boom which, statistically, is everyone. Unfortunately, there are no do-overs. It was the excitement of the free exchange of information that caused the internet’s explosive growth in the US, and that was something the Chinese government never intended to allow, and never even suggested that it might allow.

Baidu is still China’s largest search engine, but since 2012, it has steadily lost market share to Qihoo 360 (QIHU). Although the company is expanding into other markets, its once explosive growth has flattened out, and while its P/E is listed as 12 on some popular financial websites, its P/E on operating income is actually 36. Another good example of why you need to read the fine print before you put your money down.

Chart courtesy of www.stockcharts.com

Visa (V)

Visa has certainly done a good job with market penetration — you probably have a Visa card in your wallet — and V stock has done well for investors over the last five years. Even so, there are signs that the party is coming to an end. While the stock’s recent run makes it look like a growth stock, this is a mature company that makes most of its money by taking a relatively predictable slice of global economic activity. In other words, it’s a cyclical, and the US economy, we now know, is growing at only 1% annually. Other parts of the world are only hoping to do so well, and here, Visa demonstrated extremely bad timing, acquiring Visa Europe mere days before the Brexit vote. Earnings will likely grow very slowly for this company until the global economy improves, so why the trailing P/E of 33? Don’t mistake investor optimism for strength.


Chart courtesy of www.stockcharts.com

Texas Instruments (TXN)

Texas Instruments is the world’s fourth largest semiconductor company, and the world leader in analog processing chips. For those unfamiliar, these chips translate natural input, such as sound, temperature, or light, into a stream of digits so that it can be handled by other chips. The lifecycle of analog chips is fairly short, which means the company usually has something new to sell, as well as a market that needs it, and that has kept its profit margins high.

Even so, a great many of the chips this company makes go into mobile phones, and the flattening of mobile phone sales means earnings and revenue growth will not be come by nearly as easily from this point on. Also, while the demand for analog chips is steadier than that for microprocessors, it is very much subject to economic conditions. So yes, this too is a cyclical of sorts. Finally, TXN stock appears overbought at present, having risen 14% this month alone. This one has some settling left to do.


Chart courtesy of www.stockcharts.com

National Grid plc (NGG)

First, I must point out that National Grid, a London based natural gas and electric utility company, has a current forward dividend yield of 4.37%. While that’s not the princely yield that American natural gas companies were paying just a couple of years back, it beats the heck out of the zero or less than zero yield that some bonds are now paying.

But look at the number of red flags here. Natural gas prices all over the world have been wiped out by America’s surfeit of shale gas, and England’s economy remains very much at risk, (perhaps even in peril) from its EU withdrawal. Last year, the company entered revenue decline, even as its profit margin fell into decline. To paraphrase an old commercial, NGG is everywhere you don’t want to be.


Chart courtesy of www.stockcharts.com

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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