2 Stocks To Hold, 1 Stock To Short
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Many market commentators have argued that the S&P 500 is currently overvalued. In my view, while stocks are not particularly undervalued, they are largely worth holding due to the growth curve that is ahead in the economy. When investors are negative, it is often attractive to "think like a contrarian" or "buy" when "there's blood on the streets". At the same time, there are moments when earnings are uncertain or the fundamentals have been overhyped. In those instances; which are representative of UPS (NYSE: UPS), Newmont Mining (NYSE: NEM), and Amazon (NASDAQ: AMZN), I recommend either just "holding" or "shorting". Below, I review the fundamentals of each company.
United Parcel Service
Despite a generous 3% dividend yield, UPS is too expensive for my tastes. It trades at a respective 18.8x and 14.5x past and forward earnings and, in my view, is not well positioned for outperformance with a beta of 0.86. The bar has already been set fairly high at an EPS growth forecast of 11% annually over the next 5 years, so high risk-adjusted returns are not likely. Lastly, analysts are at least somewhat reserved on the stock, as evidenced by the 2.2 rating out of 5 on the Street (data from FINVIZ.com).
Profit margins have noticeably gone up to the 7.5% territory since 3Q10 versus an average of 5.1%. Free cash flow has also been a turnaround story with $5.6B generated over the TTM in 2Q12 versus -$324M in 2Q08. And the PE multiple has been around the 20x range dating back to at least 3Q07. It is, however, the secular trends that concern me. Communication is increasingly going through internet and mobile devices while shipment from goods transportation looks most undervalued in the rail sector.
While the company failed to increase dividends in 2009, it is quite generous in the capital allocation policy. $2.4B worth of share repurchases over the TTM has been complemented by almost 10% annual increases in the dividend distribution. Going forward, however, I am concerned with the sustainability of the capital allocation policy. Debt now exceeds equity by 150% and the acquisition of TNT Express will deplete the cash chest of $6B. Under such a climate, and when there are so many cheaper transportations stocks to choose from, I recommend merely "holding".
Newmont is also an uncertain investment with valuation 1.9x book value and only a "hold" on the Street according to data from FINVIZ.com. ROA, ROE, ROI are all in the single-digits, and a lot of growth is forecasted. Analysts anticipate 2013 EPS to be $5.05; but, over the trailing twelve months, the company has only yielded $1.06. This is the result of production swinging into full gear but is highly uncertain.
The firm's diversification across various countries--the United States, Australia, Peru, Ghana, Indonesia, New Zealand, Canada, and Mexico--is a plus. Production ramp up at Boddingon in Australia is offsetting production declines in Australia. North American margins have risen dramatically from 2007 to 2011 with the price of gold, but much of the firm's value is still locked up in Asia Pacific. India and China are the largest global gold purchasers. Central banks are anticipated to increase gold reserves, so volume trends are decent for the industry.
But investors need to broadly diversify and hold disproportionate interests in those with the best volume activity. Newmont has seen substantial executive turnover over the recent past. After the CEO turned out to be 20% too optimistic in his forecast that gold would close 2011 at $2K per oz, he sold 13% of his holdings. High capital expenditures at $2.8B coupled with costly disputes over the Peruvian Conga project are enough to put the company on a "hold" for right now.
When it comes to overvalued stocks, I believe that Amazon tops the list. If anything needs to be sold through Amazon then it is the company's stocks. Even compared to Facebook (NASDAQ: FB), the company trades at extremely high multiples of 300.1x and 103.4x past and forward earnings. To put this into perspective, consider that the stock's PEG ratio is 9.5x versus 4x for Facebook! This is a company that has been around for a few decades, and, as far as I can tell, has nowhere close to as fast as growth needed to justify the current valuation.
If Amazon were to grow EPS by 50% annually over the next 5 years starting from $2.38 next (versus $0.82 over the trailing twelve months), 2016 EPS would come out to $12.05. At a very generous multiple of 20x, the future value of the stock would be $241. The stock is currently worth nearly $250.
But, it gets worse... my calculation did not assume the present value of Amazon's stock. To get that you would have to discount the future stock value back by a rate that fairly considers the degree of risk. Typically, you would apply a 9% discount rate for a stock of medium risk. With the 50% y-o-y growth over the next half decade and the few barriers to entry in a climate ripe with competition, Amazon ought to get at least a 11% discount rate. That would put the present value of the stock at $143.02. Amazon may have gone up for some time, but it is one giant bubble.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Facebook. Motley Fool newsletter services recommend Amazon.com and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.