The Scariest Stocks Seem Secure

 | Apr 22, 2014 | 2:30 PM EDT  | Comments
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Stock quotes in this article:

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I was asked the other day what sectors worried me the most in the current market environment. Of course, at the top of anyone's list are the social media stocks. The high fliers, including LinkedIn (LNKD), Facebook (FB) and Twitter (TWTR), are ridiculously priced.

However, I do not find them to be the scariest. The investors and traders who own those stocks know what they bought and are aware that these are momentum and trading vehicles. They are obviously scary and I think most of the people trading these stocks have some sense of the risk involved.

The group that scares me the most is the dividend paying blue-chip stocks. The buyers of these issues tend to be more conservative. They take a great deal of comfort in owning corporations that make the stuff they use every single day of their lives. I think this creates a false sense of security because most of them are priced just as ridiculously. That 3% dividend does not offset the possibility of a 25% or greater decline in value.

I prefer to avoid the emotional debate about selling or avoiding blue chips and let the numbers do the talking. Let's take a look at the latest blue-chip to report earnings this quarter. McDonald's (MCD) reported a decline in sales with a dropoff in same-store sales in the U.S. According to the report, only higher prices kept it from being worse, as the higher average check offset negative guest traffic around the world.

McDonald's is a great company but short of opening locations on another planet, it has few great growth opportunities in its future. The company will grow earnings, at best, at a single-digit rate for the foreseeable future. The stock's 17x earnings and 6x book value is too high for a low growth company -- no matter how well known it is.

Everyone got excited when Pepsico (PEP) beat expectations last week, but exceeding the always highly accurate analyst estimates does not mean the company is going to see sparkling growth rates going forward. Its long-term outlook is for single-digit revenue and earnings growth. I don't see anything that will change that going forward unless Coca-Cola (KO) decides to close its doors.

Pepsico will be lucky to grow earnings at a mid-single digit pace over the next several years, yet investors are paying 19x earnings and 5.8x book value for the shares at current prices. No matter how much I jiggle the numbers or plug in optimistic estimates for the Street, I cannot come up with a value any higher than about $45 a share for this company.

Intel (INTC) beat estimates in the latest quarter as well. As warm and fuzzy as that may be, the fact is that profits were down, year-over-year, and revenues were pretty much flat. At first blush, the stock looks OK. It has a 14.5 PE ratio, but that's actually twice the expected growth rate for the next five years.

Intel is a great company but I can't make a case for owning the stock at this price in spite of its attractive dividend. In a bad market, this stock could easily drop back into the teens, which would make the 3.3% payout seem pretty insignificant.

Blue-chip stocks can often give buyers a false sense of security. However after a five year rise in the stock market that has led to prices tripling off the low now is not the time to be paying up for blue chip no matter how many cokes you drink a day or how many Procter & Gamble (PG) cleaning products you have in your home. If you own some of these stock that you bought years ago, I wouldn't rush to sell, as taxes alone make this is an unattractive proposition. However, I would not rush to put any new money into these stocks at current levels.

The time to buy blue chips is after a significant decline -- and that is clearly not the atmosphere today. They are overvalued given the current conditions and future prospects; hence, this is the single scariest sector in the stock market today.

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