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  1. Home
  2. / Investing
  3. / U.S. Equity

Cereal Killer and Other Stocks to Avoid

It's hard enough to find good stocks. Why bother with these 3?
By TIM MELVIN Jun 01, 2015 | 03:00 PM EDT
Stocks quotes in this article: K, MNST, KO, WAGE

Every once in a while, I stop thinking about what stocks to buy and spend a little time on which ones are best avoided or even shorted. As the bull market gets older and older, this is probably becoming as important as finding bargains.

I have no idea when the bull retires, but I do know that, in bull years, he is ancient, and some very smart guys like Sam Zell, Carl Icahn, James Montier and others have suggested that maybe there is more downside risk than upside expectation in the stock market now. I have no idea if or when they will be correct, but I see no reason to own overvalued stocks with poor prospects in the best of times.

I sat down last night after watching the Orioles' horrible effort against Tampa Bay and looked for stocks where there is simply no reason to own them. They are overvalued with ridiculous EV/EBIT and P/E ratios. With deals in frothy P/E and LBO markets occurring at an EV/EBIT of about 10, I used double that and selected stocks that had ratios over 20. For P/E ratios, I used a minimum of 30, as I have always found that to be the point where all but the very best stocks start to become stupidly overpriced. None of them has positive momentum and all had deteriorating fundamentals, with a Piotroski F-score of 5 or lower, indicating poor fundamental conditions.

Kellogg (K) is the largest company on the list. Kids are not eating cereal as much and Special K no longer appeals to many would-be dieters as it once did, apparently. The Keebler elves are getting slapped around the store shelves by competitors, and the company just seems to be stuck in something of a rut. Kellogg is making some product changes, but they will take a considerable amount of time to make any sort of difference for a company with over $14 billion in revenues. The 3% dividend may appeal to some, but I can find stocks with a 3% yield with better prospects than this one. There is not a valid reason to won the stock now. With a P/E ratio of 50 and an EV/EBIT ratio of 37, it should be avoided by most investors.

Monster Energy (MNST) shares got a huge boost when Coca-Cola (KO) invested in the company, but some liability suits and a disappointing quarter have taken the edge off this stock. There has been talk of the FDA taking a deeper look at energy drinks and health risks. That would be an unmitigated disaster for this company. Just the announcement of an investigation would send the stock into a monster decline.

The shares are not cheap by any measure, as the current P/E is 56 and the EV/EBIT ratio is 37. The F-score of 4 is a pretty good indication that fundamental conditions and prospects won't be taking a turn for the better any time soon. The stock has lagged behind the market for the past few months and I suspect it will continue to do so unless stocks turn down. Then it could be a leader in the march lower.

WageWorks (WAGE) administers consumer-directed benefit programs like flexible spending accounts (FSAs), health savings accounts (HSAs), health reimbursement arrangements (HRAs) and other employee benefit programs. While this would seem to be a pretty good business in today's complicated tax and benefit world, you are simply paying too much for the stock at current prices. The stock is trading at 90x earnings and the EV/EBIT ratio is 38. I just don't think any company is worth those price tags unless they simultaneously cure cancer, write the great American novel and win the Word Series. The F-score of 4 indicates that none of those are on the horizon, and the stock has been lagging the market for the past month and quarter. It's a decent business, but at this price there is no reason to buy this stock.

It is hard enough to pick winning stocks. I see no point in making it more difficult by investing in companies with outrageous price tags, weakening conditions and prospects with no price momentum. I see no valid reason to buy any of these three stocks right now and would suggest avoiding them and possibly consider selling them short if you are so inclined.

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At the time of publication, Melvin had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity

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