By David Sternman for Street Authority
Investing in 2014 requires a considerable amount of faith -- the faith that future profit growth will be sufficiently strong to offset currently robust valuations.
The problem with such an indiscriminate upward move is that tends to elevate shares of companies that are actually in the midst of slowing profit growth. I looked at all of the companies in the S&P 500 that are expected to see earnings per share (EPS) growth begin to slow in 2015 and fall below 10% in 2016. From there I narrowed the list down to those stocks trading for more than 20 times projected 2015 profits. This equates to a robust price-to-earnings (P/E) ratio and anemic profit growth -- which are not the ingredients for share price gains. Here's a look at ten such companies.
Document storage firm Iron Mountain, Inc. (NYSE: IRM), which is touching 52-week highs these days, is a classic bull market stock and would not be showing such vigor in a flat market. Demand for the company's services has come under pressure as clients seek ways to digitally store key corporate info. The company reached the $2.8 billion threshold in sales in 2009, but sales won't even reach $3.2 billion by next year, according to consensus forecasts. That's a 2% annual compound growth rate. Earnings, as you can see above, are also stuck in the mud. In that context, it's hard to understand why shares trade for 25 times forward earnings.
Or take confectionary producer The Hershey Co. (NYSE: HSY) as an example. It's been more than a decade since Hershey has been able to boost sales at a 10% annual clip. Investors may be focusing on the fact that Hershey's dividend is getting a lot of attention these days, rising at least 10% in each of the past three years. But we are still talking about a 2.4% dividend yield. Looking beyond EPS, Hershey hasn't managed to generate $500 million in free cash flow in any of the past five years, but it is now worth more than $20 billion. That's not the kind of multiple that attracts value-sensitive investors like Warren Buffett.
To be sure, Hershey has a solid moat around its business, but future growth prospects remain challenged as consumers watch their waistlines. In that context, Hershey's stock chart suggests the best gains have already been had and you may as well book profits and wait for the next bear market.
This rising-tide-lifts-all-boats market can be looked at in a different context. Even companies with seemingly reasonable P/E ratios mask the fact that profit growth has hit a wall. Here's a look at companies in the S&P 500 expected to boost per share profits less than 5% in 2015 and again in 2016.
To be sure, deeply cyclical companies can't simply be viewed in the context of near-term profit forecasts. Deere & Co. (NYSE: DE), for example, is entering into a trough period of earnings now, but at some point, investors will look ahead into the next up cycle, when Deere's per share profits should be on the upswing.
Yet other companies are facing stiff growth challenges, and their current P/E ratios seem stretched. As I noted two months ago navigation device firm Garmin Ltd. (Nasdaq: GRMN) faces stiff competition and technology obsolescence, which explains why flattish sales "could be followed by outright sales declines in coming years." Though shares have drifted lower in recent weeks, they still trade at a multiple slightly higher than the broader market.
Perhaps the classic low-growth/high-multiple stock is Campbell Soup Co. (NYSE: CPB), which has been posting moderate annual sales declines when acquisitions are excluded. Management recently lowered fiscal (July) 2015 EPS forecasts to around $2.50, which would be roughly a dime lower than fiscal 2014 profits. Yet, you would never know this business is stuck in neutral by glancing at the three-year stock chart. A bull market tends to mask such duds.
Risks to Consider: As an upside risk, some of these companies will be pursued as acquisition fodder if larger, more successful rivals see their growth weakness as an opportunity to pounce. In the event of a correction, these stocks will be some of the hardest hit as their stock price returns to fair valuations.
Action to Take --> If the U.S. economy rebounds in 2015, as many strategists expect, than many companies in the S&P 500 will see a bump in sales and profits. Yet the extended bull market has already anticipated such a rebound, which makes this a good time to start pruning any companies form your portfolio that sport P/E ratios well in excess of their earnings growth rate. At best, these stocks have likely already generated all the upside that they can from this bull market, and at worst, they would be the first stocks to be sold in a shift towards a defensive market.
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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