The stock market is a dynamic place to invest. You have to be able to balance future expectations with past performance and somehow come up with a valuation that makes sense. However, sometimes this doesn't work and we wind up with violent swings in the market as we've witnessed since July.
As much as we'd like to "set-and-forget" our portfolios, with the Internet making company-specific information easier to obtain and trading costs falling, it's becoming easier for the average Joe and Jane to get involved in the market. As much as I like the idea of more people investing in their future, it's also had the adverse effect of increasing volatility, because there are just as many uninformed traders moving the market as there are seasoned investors.
So as we near the end of 2011, I've decided to take a step back and take a closer look at five companies that have been strong performers over the trailing-12-month period that I feel could be knocked off their high horse in 2012. Under normal circumstances these stocks work as great set-it-and-forget-it long-term holds, but I'm predicting they will vastly underperform the S&P 500 next year.
Altria (NYSE: MO )
I know...blasphemy! Who in their right mind would ever bet against our greatest sin, smoking? Me, that's who!
Altria is a shell of the company it once was. The days of rapid growth have been crushed by the U.S. government and its increasingly aggressive antismoking legislation. In 2012, U.S. cigarette manufacturers will be required to place noticeably larger warning labels on their packaging noting the dangers of smoking, which can only be seen as a negative for the industry as a whole.
Altria continues to do what it can to keep long-term shareholders happy, including share buybacks and dividend increases, but you can only play this game of smoke-and-mirrors for so long before shareholders get wise. There's simply no growth left at Altria. Since 2007, Altria's market share in the U.S. has hovered in a very tight range of 49%-51%, but cigarette volume remains constrained. Altria also announced just last week that it would be laying off 15% of its workforce in response to a decline in sales. This doesn't bode well for Altria in 2012, and I'd suggest Altria's best days may be behind it.
GlaxoSmithKline (NYSE: GSK )
The patent cliff is a worry for all major pharmaceutical companies, but none more so than GlaxoSmithKline, which is facing the prospect of one-quarter of its revenue being at risk of generic competition by year's end.
Glaxo's two blockbuster drugs, Advair for the treatment of asthma and Avandia for treating diabetes, are scheduled to lose patent exclusivity prior to the end of 2012, and there's not much Glaxo can do about it. The only saving grace for Glaxo thus far has been that no pharmaceutical company has been able to produce a generic version of Advair yet, but I'd say it's just a matter of time before it happens.
Even more of a head-scratcher is Glaxo's valuation, which, for a pharmaceutical, isn't cheap. With the majority of pharmaceuticals valued at single-digit forward P/Es, Glaxo is trading at 12 times forward earnings. Glaxo appears even more overvalued when you compare it to a generic producer like Teva Pharmaceutical (Nasdaq: TEVA ) , which has a huge generic-drug portfolio that has significantly less risk from the dreaded patent cliff. Mark my words, Glaxo's revenue drop-off will be steep when the generics begin their assault.
McDonald's (NYSE: MCD )
I'm not purposely trying to attract the ire of Ronald McDonald, but McDonald's valuation has gotten completely out of hand. As I described during my "bashing" of McDonald's last week, there is a myriad of potential problems.
The European debt situation has all the makings of a euro killer, and with McDonald's deriving quite a benefit every quarter from currency translation gains, it could come as quite a shock to shareholders if the company misses by a mile due to a weakening euro.
Another problem is inflation. Food costs continue to rise beyond McDonald's own expectations and I would anticipate that unless the company increases prices and risks alienating some of its consumers, especially in Europe, its margins will contract.
Finally, there's the company's valuation, which is the primary cause for concern. Since 2002, its price-to-book has tripled and its price-to-cash flow has doubled. It's no longer the value it once was and I'd go so far as to say that at 16 times forward earnings, and with revenue growth expected to slow to 5% next year, Mickey D's is expensive. These golden arches may be made out of fool's gold in 2012.
Capital One Financial (NYSE: COF )
If you think European banks are the biggest concern heading into 2012, you may have another think coming.
Capital One Financial derives more of its revenue from its credit card division than any other large U.S. bank. Based on its third-quarter report, almost 80% of its revenue was tied to net-interest income. This puts Capital One at a considerably greater risk of trouble if the U.S. economy were to dip back into recession. Although net charge-offs dropped during the quarter, delinquencies beyond 30 days rose.
The truly scary part is that the U.S. economy is giving off the initial warning signs that every Capital One shareholder should fear. Foreclosure rates are once again on the rise, housing prices are falling as some pundits are calling for a triple dip, and mortgage applications are drying up with even the slightest bounce in interest rates, despite lending rates at 60-year lows. If homeowners find themselves unable to meet their obligations, Capital One will be the first bank to feel the effects of delinquencies. Do yourself a favor and stick this stock back in the safe deposit box.
Baidu (Nasdaq: BIDU )
Baidu may fit the bill as a Motley Fool Rule Breaker selection (and it has lived up to its billing), but rules aren't the only thing that Baidu is breaking. Baidu's valuation appears to be headed straight to the stratosphere with the company valued at 29 times forward earnings, 61 times cash flow, and a laughable 22 times book value.
Baidu has been able to maintain these nosebleed valuations for quite some time because of its dominance in China's search engine market, where it currently holds about 70% market share. The concern I have is with China's slowing growth. Although Baidu's guidance bucked my projections last week of a slowdown, I highly doubt this fast-growing Internet company will be able to keep up its torrid growth rate in light of Chinese government initiatives designed to slow growth and increasing competition from Sohu.com (Nasdaq: SOHU ) .
China's GDP forecast has already been reduced by Goldman Sachs and Credit Suisse and I figure it's only a matter of time before the World Bank follows suit. Baidu's valuation is simply too rich for my blood and I suspect it could be in for a rough 2012.
With volatility as the new norm, you can't help but take a critical eye to your investments. While these companies may provide investors with the chance for long-term appreciation from their current levels, I'd be willing to bet my Motley Fool CAPS points against them in 2012.
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