There is another group of stocks I want to avoid entirely if the grizzled old guys turn out to be right about current stock market valuations. While the old guys tend to be very early in getting concerned about market levels, in my experience they are usually proven right. Prior to just about every major market event of my career, the chorus of older, wiser investors was getting nervous a year and sometimes even a little more before we got a severe correction in the market.
The one type of stock you really do not want to own at such times are those companies in hot sectors that are not doing all that well. Their difficulties may be disguised by industry or sector strength, but when that fades, investors will focus more on their poor financial prospects and things could ugly quick.
In that case, it is as much current conditions and future prospects that are the major concern, so I used Piotroski F-scores and not the Z-score credit model to isolate stocks I think you want to avoid. I looked for stocks that had low scores on the nine-point financial conditions and prospects model and were in the technology, health care and consumer-oriented sectors that have been strong over the past couple of years.
AmerisourceBergen (ABC) is a great example of a stock that you probably want to avoid owning right now. On the surface, things look great as the company has made two multibillion-dollar acquisitions this year and has announced a large stock buyback. The stock is up a little bit in a down market and the health care sector is on fire. A deeper look, however, shows us that everything is not that great.
As a result of large borrowing connected to the deals it has made, Amerisource Bergen has put stock buybacks on hold until at least sometime in 2016. The Piotroski F-score is just 3, which tells me conditions are not improving any time soon. Institutions own 86% of the outstanding shares, so if they decide to exit this underperforming health care name, the price could take a huge hit.
Debt ratings agency Moody's seems to agree, as it recently downgraded the outlook to negative, saying, "The negative outlook reflects Moody's concerns that ABC's more aggressive acquisition strategy will reduce its financial flexibility and could result in higher leverage for a protracted period of time." Moody's believes that if the performance of acquisition PharMEDium is negatively affected by regulatory matters, it could delay deleveraging.
While social media have been a market darling for much of the past few years, LinkedIn (LNKD) is a stock I have suggested avoiding for some time, and prospects have not really improved. The Piotroski score is an almost rock-bottom 2 and the stock trades at nosebleed valuations. I use LinkedIn and thinks it's a good site, but it is not worth the ridiculous 55x next year's hoped-for profits. This will be a first-out-the-door stock if market conditions change and institutions own almost 90% of the company, so the selling could be intense.
Wall Street analysts have some very optimistic and aggressive year-ahead projections for Post Holdings (POST) over the next year, but the F-score of just 4 suggests they may fall short, even if the company hits the projection of 48x the hoped-for earnings. Cereal is not that exciting a business, and the only exciting news from the egg business has been the fact that avian flu fears are raising prices and pressing margins. The business is expected to see single-digit earnings growth over the next five years, and I simply cannot find any way to a value anywhere near current levels. I used three different models and formulas, and even using some embarrassingly aggressive assumptions, I could not get my number any higher than $35 a share. That's well below the $61 a share that the stock fetches under current market conditions.
One observation from my search for potential downside leaders if we get a correction is that the screen I have run so far contained dozens of smaller biotechs. I have long maintained that anyone who is trading or investing in these stocks without in-depth knowledge of medicine is simply gambling. Should the markets turn south, many of these stocks will likely implode without sector-related buying to prop them up. If you have smaller biotechs in your portfolio, you should be doing a financial checkup on all of them right away. I think the results will shock you. Many have weak balance sheets and poor prospects and would be decimated in a bear market.
It may take a while for markets to come around to the old guys' point of view, but they usually do in good time. The time to prepare your portfolio for a bad market is before it gets here. A little financial prudence while markets are still elevated can pay off big down the road.