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  1. Home
  2. / Investing

4 Market Segments to Avoid

These sectors are full of high-priced, low-growth stocks.
By TIM MELVIN Sep 13, 2016 | 02:00 PM EDT
Stocks quotes in this article: CG, BRK.A, BRK.B, KO, PEP, THS, PF, YORW, CWT, WTR, WCN, ABT, BCR, PFE, STJ, CAG

I wrote yesterday about the wisdom of investing like private-equity funds by selecting companies that are growing but still selling at low multiples of EV/EBITDA. But that got me thinking that to really invest like private-equity firms, you need to follow their current lead and do a lot more selling than buying -- and here are some key market segments for that.

Almost all of the leading private-equity firms said during their first- and second-quarter conference calls that they were selling more than they were buying, and that's been true for a few years now.

For example, David Rubenstein of the Carlyle Group (CG) recently told Fox Business that private equity has been returning more money to investors over the past five years than the amount of new money that's come in. After all, he noted that today's deal multiples are higher than they were before the Great Recession, making it tough for private-equity firms to find bargains.

Now, if private-equity firms like to buy companies that are growing but have low multiples, it makes sense to assume that they're also looking to sell companies that aren't growing but trade at high multiples. This follows the advice of investing legend Charlie Munger of Berkshire Hathaway (BRK.A) , (BRK.B) , who famously quoted 19th century German mathematician Carl Jacobi as saying: "Invert. Always invert."

To do this, I recently screened for stocks that:

  • Have above-average EBITDA multiples.
  • Haven't been growing over the past five years.
  • Have had poor recent results.

Interestingly, I got a much longer list of stocks with this screen than I found for yesterday's column on "buy" candidates that I think private-equity firms would like.

Let's check which stocks and sectors made my "sell" list:

Consumer Staples
The first thing that's glaringly obvious when you run this screen is that investors searching for yield and comfort have bid up consumer-staple stocks to unreasonable prices given the sector's very low levels of corporate performance and future prospects.

Coca-Cola (KO) , PepsiCo (PEP) , ConAgra (CAG) , TreeHouse Foods (THS) and Pinnacle Foods (PF) all made the list. They cost a lot -- all of them currently trade at EV/EBITDA ratios greater than 15.0 -- even though analysts don't expect any of them to grow at double-digit rates over the next five years.

Water Companies
I see a clear trend of growing demand for clean water, but the bandwagon for water utilities has gotten a little crowded. After all, these stocks are going to have a hard time growing any faster than a U.S. economy that's far from robust right now.

I also think that the search for adequate clean water will be a huge cost for utilities, so they might not be the best way to invest in future demand for clean water. California Water (CWT) , York Water (YORW) and Aqua America (WTR) all currently trade at premium EV/EBITDA ratios despite very low realized and expected growth. So, I think the idea of putting any new money into these stocks at current prices is all wet.

Trash Removal
Solid-waste firm Waste Connections (WCN) also made my list of potentially overvalued stocks to sell.

On one hand, WCN represents a perfect example of the private-equity mindset, as Waste Connections is in the trash business and trash is a great business. We make more of it every day, and it all has to be picked up and hauled away to landfills or recycling centers. Companies like Waste Connection profit at every step along the way.

It's true that the trash business delivers consistent cash flows and is pretty recession resistant. If you bought WCN back in 2009 when everything was on sale, you could have purchased the stock with an EV/EBITDA ratio between 6.0 and 7.0 -- a multiple that skyrocketed over the past seven years. You would have earned more than 20% in average compound returns.

But while trash is still a great business, growth is slowing as a result of the slow U.S. economy. So, it's time to sell the stock.

Health Care
This is another sector that has the potential for huge long-term returns, but where some larger names have already seen their prices pushed to the point where it makes sense to lighten up or steer clear of them. Abbott Labs (ABT) , C.R. Bard (BCR) , Pfizer (PFE) and St. Jude Medical (STJ) all make the list of overpriced low-growth companies that you should avoid or sell at current levels.

The Bottom Line
The above screen makes it easy to see why most private-equity shops have been doing more selling that buying over the past year or so.

Simply put, there are far more companies with low to no growth that are trading at premium valuations these days than there are bargain-priced companies that sell for attractive prices.

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

TAGS: Investing | U.S. Equity | Markets | Short-selling | Stocks

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