3 Stocks to Avoid in 2010

Good riddance, 2009. Welcome in, 2010. What's in store? The honest answer is: I don't know, and neither do you. But there are companies I wouldn't dare touch as we enter the New Year. Here are three, along with a few reasons why.

Amazon.com
Don't beat around the bush: Amazon.com (Nasdaq: AMZN  ) currently trades at about 53 times 2010 earnings estimates. Those who own the stock speak endlessly about how well shares have performed lately. Analysts revere the company in ways most deities would envy. This should scare you. 

What's ironic is that we're staring the next decade with parallels to how we started the last. A decade ago, the story was:

  • You don't understand: Amazon is changing the way retail works. 
  • NASA can't even calculate its growth potential.
  • Management is brilliant.
  • But holy smokes, it's ridiculously overvalued.

Today, the story seems to be:

  • You don't understand: Amazon isn't a bookstore; it's a retail king. And a crouching tiger in cloud computing.
  • Kindle will replace everything you put in front of your face.
  • But … hmm … are shares overvalued?

Amazon is an extraordinary company that will grow internally for years. Average estimates call for more than 25% growth for at least five years. Shareholder returns are another thing entirely.

A decade from now, we'll probably reflect on Amazon's achievements, but wonder why shareholder returns were pathetic at best. That's just the nature of a stock that sells for nutty multiples. Ask anyone who invested in Google (Nasdaq: GOOG  ) or Chipotle (NYSE: CMG  ) in late 2007, or Microsoft (Nasdaq: MSFT  ) in 2000. When a company is priced for perfection, it's quite possible to grow revenue and earnings at fierce clips, but still leave shareholders in tears. It happens over and over and over and over again. 

Moody's
I won't belabor the story behind credit rating agency Moody's (NYSE: MCO  ) . Its shortcomings are well-documented. Instead, I'll focus on three potentially overlooked headwinds:

  • Regulatory roundhouse: A few weeks ago, the House of Representatives passed a mammoth 1,279-page financial overhaul bill. Part of the bill honed in on rating agencies, with a goal to "reduce market reliance on credit rating agencies, and impose a liability standard on the agencies." Digging deeper, you'll find threats to "remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations." To be fair, the language of the bill is less ruthless than some imagined. But frankly, I'd prefer not to be on the naughty list of legislators who like to grandstand and inflict pain just to prove a point.
  • New competition: The key arguments in support of investing in the rating agencies is that competition is meager. In general, it's true. But earlier this month, Morningstar (Nasdaq: MORN  ) came out announcing it'll begin to dabble in credit ratings, too. Morningstar's press release put it best, saying "Investors benefit when they have access to multiple perspectives on an investment." Hear hear! And joining the game while the big rating agencies are mending bruised reputations is the most effective time to do some damage.
  • Value, meet reality: I don't think Moody's is going out of business. I don't think it'll be regulated into nothingness. But when you look at shares currently trading at 16 times earnings, and a balance sheet heavily composed of goodwill and intangibles, then factor in the above two threats, I don't see how investors are setting themselves up for anything but dice-rolling or misery. 

Caterpillar
Caterpillar (NYSE: CAT  ) is up nearly threefold since bottoming out in March. That's fantastic. But asking whether the rebound has been overkill might be useful. And I think the answer is yes.

Shares currently trade at about 21 times 2010 earnings estimates, which seems extreme. But this isn't an entirely helpful metric, because earnings could explode if global economies rebound from what some see as currently depressed levels.

Fair enough. So we'll take a longer view and look at four-year earnings per share estimates:

2010

2011

2012

2013

$2.58

$3.87

$5.10

$5.21

Source: Capital IQ, a division of Standard & Poor's.

Looks great. But then I looked at Caterpillar's 15-year average P/E multiple. It's 15. So, let's say everything goes according to plan and earnings double to $5.21 per share. Then we'll slap a historical average 15 multiple on the stock, which would bring shares to about $78 (compared to today's price of $58) by 2013, or an average compound yearly return of 7.7%. Two conclusions come from this:

  • If a company doubles its earnings, you deserve a heckuva lot more than 7.7% per year.
  • What if global economies don't spring back? What if infrastructure, housing, and commercial real estate fall back into misery? Crazier theories have been proposed. There's no room for error here.

Your turn to chime in
I don't think any of these companies are inherently terrible; just that factors seem stacked against them. What do you think? Feel free to share your thoughts in the comment section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Chipotle Mexican Grill and Google are Motley Fool Rule Breakers selections. Amazon.com, Moody's, and Morningstar are Motley Fool Stock Advisor recommendations. Moody's and Microsoft are Motley Fool Inside Value picks. Motley Fool Options has recommended a diagonal call strategy on Microsoft and writing puts on Moody's. The Fool owns shares of Morningstar and has a disclosure policy.


Read/Post Comments (27) | Recommend This Article (43)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 30, 2009, at 1:24 PM, RetireOrExpire wrote:

    I agree on AMZN and MOODY but not sure about CAT.

    If we look at next 2 years the earnings should grow from 2.58 to 5.10 wouldn't we expect the P/E to expand beyond traditional 15.

    Say a 18 multiple in 2012 and $5 per share we are looking at $90 stock. That's a 16% annualized return.

    Of course I would look to buy it on dips but if you believe the growth the stock doesn't look overvalued.

    Now on the other hand if you don't believe the growth then there is no reason to consider it.

  • Report this Comment On December 30, 2009, at 1:35 PM, plange01 wrote:

    with the US just entering its second year in a depression 2010 will be the year of the bankruptcy..sirius,hertz,ual,moodys.rite aid.to name a few...disgraced and already bankrupt..GM top of the list!chrysler,most of the major home builders,buffett owned geico!near 0 in customers renewing policys...the lis will be endless..

  • Report this Comment On December 30, 2009, at 1:54 PM, GirlScoutDad wrote:

    I think your rate of return calculatons on CAT omitted the hefty 3% dividend.

    With the dividend intact, the returns should be over 10% annually (in the original post), or nearly 20% annually (per RetireOrExpire's scenario assuming a PE of 18).

    Either way, CAT couldn't possibly be such a bad investment going into 2010 !!

    Heck, i might even pick some up myself on a dip.

    Disclosure: I don't own CAT at this time.

  • Report this Comment On December 30, 2009, at 2:37 PM, RagnarRedbeard wrote:

    Hold on a minute. In an article today -

    "Companies You Should Buy Right Now"

    By Brian Richards and Tim Hanson

    they recommended Amazon.

    Now Morgan Housel says to avoid Amazon. Do these talk to each other at all before they publish?

  • Report this Comment On December 30, 2009, at 2:45 PM, jspegele wrote:

    Amazon is still one of David's core stocks. The stocks that they suggest we own at least 3 of. So it's a fool's stock here, but a Fool's stock in the Stock Advisor?

  • Report this Comment On December 30, 2009, at 2:49 PM, PhulishMortal wrote:

    Ragnar, I don't expect for all the writers at TMF to agree with each other; as a matter of fact, I'm pleased that they don't. I like getting differing viewpoints on businesses. It gives me a much more rounded picture than if we had a bunch of guys getting together in an office somewhere going, "OK, we're bullish on these stocks and bearish on those, right?"

  • Report this Comment On December 30, 2009, at 3:06 PM, TMFBrich wrote:

    Hi Fools,

    Brian Richards here. I wanted to comment upon a few of these, er, comments.

    The Motley Fool has no top-down editorial mandates; every Fool is free to write what she believes. As our name suggests, we are a motley bunch, even though we tend to ascribe to a similar investing outlook (long-term, company-focused investing). So, while most Fools fit under that big philosophical umbrella, each person is entitled to her own opinion on an individual stock. (This company was founded by two Fools with different viewpoints. David and Tom Gardner have been disagreeing about stocks for years, and have built our flagship newsletter, Stock Advisor, on the power of skepticism and debate.)

    If a writer of a Fool.com article argues the bear case for a stock recommended in one of our premium newsletter services, we do not censor such disagreement. Indeed, we encourage it, as readers of our Dueling Fools feature know.

    We truly believe that reading and considering different viewpoints, even if they disagree with a newsletter's official view, or your own, help us all to become better, more informed investors.

    In this case, yes, Amazon is a "core" recommendation for David Gardner in Stock Advisor. He clearly believes in the stock. In the above article, Morgan articulates his viewpoint that he thinks Amazon is a great company with an overly optimistic valuation. In my own article, which Ragnar cited, I too state that Amazon is a great company (we didn't delve into valuation in that article).

    Foolish best wishes in the new year.

    -Brian Richards

  • Report this Comment On December 30, 2009, at 3:11 PM, dantefromsomm wrote:

    I agree about cat completly.They are up to much in price/value.Not to mention i run heavy equipment and are work has not gotten back to the pace it use to be so i cant see that cats has either

  • Report this Comment On December 30, 2009, at 3:23 PM, oghowie wrote:

    I've been wanting to short MCO for a week now but Etrade saws it can't borrow the shares? What gives? Is the short interest too high or does it depend on the broker you're using?

  • Report this Comment On December 30, 2009, at 3:50 PM, pondee619 wrote:

    I used to work at the track to pay some bills while at school. The track had "touts", people who would tout (recommend) a horse upon which to bet. There were often serveral tout sheets to purchase to get your tips. What is not readily observed from casual attendence at the track, but easily seen from someone working there, or attending on a daily basis, one tout published several letters touting different horses in each race. The very next day the "winning" sheet would proudly proclaim its excellence in the hopes of getting more buyers. The new patrons of the day would see the excellent record and buy that sheet. At the end of that day (and at the beginning of the next) the winning sheet would proclaim its excellence in the hopes of getting more buyers. Not necessarily the best sheet from the day before, but by the same publisher.

    This cycle would repeat itself day after day.

    And, so it is that Amazon is a top pick that should be avoided.

  • Report this Comment On December 30, 2009, at 3:50 PM, pondee619 wrote:

  • Report this Comment On December 30, 2009, at 5:46 PM, Friendlysurfer wrote:

    Yep, could not agree more. However: A lesson I learned.... luckily it was not that painful. Do NOT SHORT the massively overpriced stocks.... the overpricing or how I might call it as a non native English speaker, it might continue .... a long.... a VERY LONG time....I went short Amazon when it was MASSIVE overprized and on the same time I went LONG WITH something OK, never mind, it was EBAY which for that time priode performed almost as well. Never the less, I set myself a MAX loss on the difference (10k) and I got out.... and I did not like it, I wanted to continue, since I was 100% sure Amazon was overvalued.... NOW TAKE THIS: at USD 50.....

    amzn is NOW at over 130....

    to cut it short: I would have lost lots of money not cutting my short postion

    Overall, yes, I did make money out of going short on overvalued stocks, but NOT thöse I counted most on loosing

    Cheers.... : CUT your losses, AND do not bet all on ONE.... diversify

  • Report this Comment On December 30, 2009, at 6:45 PM, SaulR80683 wrote:

    I've written a number of books for English speaking people learning French for school or for travel (French Key Words and Expressions, French Faux Amis, etc). They are sold on amazon.com and about a year ago I uploaded a digital version to be sold on Kindle.

    At first Kindle sales were small, then about 8 months ago they picked up a bit as Kindle became more popular but were stable more or less through October. November sales were 40% greater than average and 25% greater than the previous best month.

    December is already more than double the previous average and up 80% from November's record.

    Now, lets look at three things:

    1. People buy books on Kindle for themselves, not for gifts on someone else's Kindle. The increase in sales isn't due to Xmas gift giving.

    2. November and December aren't when college students are buying books for school.

    3. This isn't summer holidays when people are preparing to go to Europe.

    Conclusion: More than double the number of books are selling on Kindle this month because there are now probably more than twice as many Kindles out there. That means Amazon is selling a humongous number of Kindles this quarter. (Some of the Kindles themselves may be presents, of course). Those Kindles will keep people buying books. It's a game changer.

    JMHO

  • Report this Comment On December 31, 2009, at 1:54 AM, CD101C4 wrote:

    A good and timely article... reminds me of a quote from the great investment guru, Benjamin Graham "Obvious prospects for physical growth in a business do not translate into obvious profits for investors"... Hence, the current valuation must be taken into account before investing, no matter what the bosses in MF are recommending. Thanks for a contrarian viewpoint, Morgan.

  • Report this Comment On December 31, 2009, at 10:08 AM, JimNKate wrote:

    I agree with the sentiment on Amazon (reminds me of the tech bubble), and I know really little about Moody's but agree about the regulatory nightmares it faces. CAT is another story, I think. True, it's not likely to advnace massively from here, so if you have a short time horizon or you're looking for the big multiples and are willing to take on the risk that implies, go for it... and sell me your CAT position.

    Why? The whole world is going to be spending more in the coming decade or two on infrastructure after underinvesting-- including a lot of new gen transport. Also, tak into account a nice, healthy dividend and very responsible management, and you have a picture of a solid, safe investment. Not so much for twenty-somethings, but for those of us a few years beyond that, a great holding from this important sector.

    Two out of three is good, Morgan. I rarely agree this much with analysts.

  • Report this Comment On December 31, 2009, at 10:13 AM, livinonfull wrote:

    Well when as an organization you take both sides of stock future result then you can always claim you were right no matter what happens.

    You are off base on Cat. It will go well beyond the $78 you predict!

  • Report this Comment On December 31, 2009, at 12:04 PM, gszesz wrote:

    A comment on Brian Richards post. It's fine to have different opinions on a stock, but it's confusing to be paying for advice from a source only to have another contributor from that source take the exact opposite position. It would be great to see a rebuttal from David on Morgan's points as to why Amazon is still a Core stock to purchase. It would be foolish to think David should respond to every counter opinion, but since this is coming from within, I think a reply is merited.

  • Report this Comment On January 01, 2010, at 9:51 AM, pondee619 wrote:

    gszesz:

    "why Amazon is still a Core stock to purchase" because if it goes up, the fool will take credit for the pick. If it goes down Morgan Housel will brag about how you were told to avoid this stock. Those the remember the contradiction will just go away. When you pick both sides to the game, the only one who loses is he/she who takes the advice.

    I can't see how a stock can be a top pick and a stock to avoid.

  • Report this Comment On January 01, 2010, at 11:33 PM, goalie37 wrote:

    10 years ago, there were many reasons to be bearish on AMZN. The company ultimately succeeded, but I was glad to let someone else make money on the stock. Now the only bear case seems to be valuation...albeit a very good bearish case. Should the market present an opportunity, I plan on being a buyer of AMZN.

  • Report this Comment On January 03, 2010, at 10:46 AM, johick wrote:

    I totally agree with gszesz it is wrong for a subscription newsletter to publish conflicting reccomendations.I may have to rethink my future sub

  • Report this Comment On January 04, 2010, at 6:04 PM, woodyzx12 wrote:

    You guys amaze me...first you have Cat listed as one of the "10 best for 2010 investing", then you list Cat on your "3 stocks to avoid for 2010" list....I guess you cover yourself with that line up of investment advise eh??

  • Report this Comment On January 04, 2010, at 8:33 PM, TMFHousel wrote:

    woodyzx12,

    I (Morgan Housel) never listed CAT as "one of the 10 best for 2010 investing." I believe you're referring to a list of companies CAPS members picked. I'm free to disagree with them, as I did. This isn't "covering ourselves up." It's just a difference in opinion.

    -Morgan

  • Report this Comment On January 04, 2010, at 11:35 PM, gregorypierce wrote:

    I have a few others that I would add to the list:

    BBI - Anyone still sitting on these should just roll them up and smoke 'em. The company is absurdly deep in debt and having to cut deep into its only profit center (retail stores) to pay its bills. With Redbox churning kiosks, Comcast churning On-Demand, and Netflix just continuing to dominate across two channels - Blockbuster needs a lot of cash and faces really poor prospects. They're done... its just a matter of how long and how many more bank and venture capital dollars chase this one down the toilet.

    PALM - Well, the Pre was interesting but the market quickly moved on to the new iPhone and Android based phones and devices. Hell your next toaster is likely to be running Android. For all Palm has tried, it launched too little too late into a market that simply has no place for it. RIM still owns the business, APPL still has the consumer space pretty locked and where they don't NOKIA and GOOG dominate by providing platforms that people want to use. Like BBI, this one is circling the drain.

    FSLR - First Solar was absurdly overvalued at 200 and its still overvalued at 110. The market FSLR wants to compete in isn't as large as their valuation indicates and with foreign competition coming over ALREADY with cheap Chinese goods in mass quantities, margins are already dropping like 2007 valuations.

  • Report this Comment On January 08, 2010, at 11:59 AM, dave22q wrote:

    mining equipment (BUCY,joyg) is far better bet than CAT under most any reasonable recovery senario.

  • Report this Comment On January 08, 2010, at 2:10 PM, TriangleT wrote:

    Ok, I'm new to all of this--not a lot of money to invest but want to learn. I subscribed to the newsletter last October and made a few nervous first stock choices based on the recommendations. I found myself on the plus side, but who wasn't last spring?

    I made a couple other choices on my own, based on where I personally I see the world moving -- I bought Ford at $1.17 and FedEx when it was in the $50s. I'm on the plusi side with those, but again, I didn't have much to invest.

    Based on the newsletter's recco, I really went for it with Amazon when it was $134.40. Now it's down, which happens -- I know it's my gamble. BUT I, too, am disturbed by the totally opposite opinions. I was looking at the Motley Fool as a learning tool -- and I have learned this: It's anybody's guess. Perhaps that alone was worth the eighty-nine bucks -- but Fool me once ...

  • Report this Comment On January 08, 2010, at 7:12 PM, mchuckie wrote:

    Cat was the very first stock I ever owned, purchased some 12 years ago. I continue to believe in the big yellow equipment manufacturer. Globally, governments will continue to invest in infrastructure and there is no better equipment in the world. It will probably not be a ten bagger, but if there is any recovery at all, and it is led by government spending, Cat has to purr.

  • Report this Comment On January 11, 2010, at 5:48 AM, HEATH313 wrote:

    I have CAT, up 130% since I bought it and Amazon, up 82% (in $ slightly less good in €). Looks like I should hold Amazon, but definitely wavering on CAT. Is it time to take the profit? The money might perform better elsewhere?

    I haven't spent much time in this community but have used it as a quick check for what to buy as did a lot if investing last year. So far its been good, as I believe in spreading the risks and bought a lot of recommendations. Only Gamestop shows negative returns, the rest are doing ok. Nobody can be right all the time, but its a helpful forum to get some ideas. Disagreement in the ranks is probably a good thing ! On the other hand for us non $ investors, the horrible $ slide has depressed the results a bit. Hopefully the $ will make up some ground in 2010.

    One other stock I am hovering on, I have Cadbury which went up on take over rumours, currenly +43% on what I bought it at but slipping slightly. Time to drop it or hold on?

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