The stock market surge has seen the share prices of some companies shoot to the moon. Whilst there are some bargains still out there, these six stocks are ones to avoid.
Regular readers of my missives will know I'm turning relatively cautious about the stock market over the coming few months.
I know "a few months" is a very short amount of time, but as we saw in October last year and March this year, a lot can happen in just "a few months".
The main reasons for my caution are threefold…
1) The market has gained a lot of ground in a very short space of time. Some FTSE 100 and FTSE 250 stocks have more than doubled or even trebled over the past 3 months. I just get the feeling the market has gotten ahead of itself.
2) The economy is still facing some stiff headwinds. We are still going through the biggest recession since the Great Depression. The pain is not over just because we've had a couple of months of outstanding stock market performance. This is not going to be a V-shaped economic recovery.
3) The prices of some individual stocks seem to have gotten somewhat ahead of themselves. The economy will recover, and the market is right in looking forward to a brighter future, but in some cases, it appears to be factoring in some best-case scenarios.
It's the third point I want to explore today. Below I've listed 6 stocks I think could struggle to make headway in the coming months and maybe even the coming years. They are not necessarily short-selling candidates -- I don't short, but if I did, I'd be looking for companies with unsustainably high levels of debt -- but if you own them, it might be prudent to consider taking some profits.
The tricky part about stock picking today is trying to gauge what a 'normal' level of profitability will be for these and other companies in the future.
Spending Like The Beckhams
My thinking is that, for many companies, the level of profitability in 2006 and 2007 was abnormally high. Back in those go-go days, the global economy was fuelled by an enormous credit boom, Money was cheap, and consumers and companies alike spent it like the Beckhams.
By far the majority of companies are forecasting lower profits than those achieved in 2006 and 2007. There are precious few companies who've not been adversely affected by the global recession.
IF, and it's a BIG if, some of these companies were able to return to the level of profitability they enjoyed in 2006 and 2007, even after the good run they've had over the past 3 months, they'd still be looking very cheap today. I just think that level of profitability is at least 3 to 5 years away for some companies, with others never getting back to their heyday.
The World Is Not Out Of The Woods
Just take a look at some of the recent outlook statements for the companies listed above, with my highlighting, and make up your own mind…
- HSBC: Turning to the macro-economic environment, the future remains highly uncertain, with signals from the global economy very mixed. Economic activity remains very depressed in spite of historically low global interest rates… So there are some encouraging signs, but the world is by no means out of the woods.
- Kingfisher: Looking ahead, we…continue to plan for a particularly tough balance of the year in our major markets. As a strong business with tight control over margins, costs and cash we are increasingly better placed to benefit when consumer demand improves.
- CSR: The macro-economic environment has clearly impacted levels of demand across our industry and will undoubtedly continue to present challenges.
- Topps Tiles: We recognise that there are key uncertainties in the economic outlook with ongoing pressure on consumer spending levels.
The Long Hard Slog Ahead
Most people realise the economy is going to continue to go through a tough patch for the rest of this year, and probably into next year too. After that, it appears the stock market at least is factoring in a return to some sort of level of normality.
Yes, there will be a recovery. Yes things will improve. But it's going to be a long hard slog. We are going to have a new government between now and the middle of June 2010, and the indications already are that we are in for higher taxes and reduced government spending.
As for the stock market, I'm avoiding companies like those listed above -- companies whose share price appears to already be factoring in a strong recovery, both in their own earnings, but also in the health of the economy. To my mind, the risk outweighs the potential reward.
Plenty Of Great Stocks Have Been Left Behind
But there remain plenty of stocks which have a) been left behind in this recent stock market rally, b) sport modest valuations and c) have strong, lasting competitive strengths.
If you are looking for such stocks -- companies with lower risks and higher rewards -- you may want to take a free 30-day peek at our Champion Shares premium stock picking service. Chief Analyst Maynard Paton's next update, including his very latest stock recommendations, is out this Wednesday. Click here to get instant access to all his past research, and to ensure you receive Wednesday's update.
More on the economy and the markets:
> Bruce Jackson does not have an interest in any of the companies mentioned in this article.
