5 Great Companies That'll Disappoint Investors

The beginning of the year is a great opportunity to take stock of one's portfolio. If you invest in high-quality businesses, it's easy to fall in love with the shares, believing that they will always perform in line with the underlying business. Not so! Once it has outrun its fundamentals and is overpriced, no stock will provide acceptable returns, except in the short term (which pertains to speculation, not investing). Below, I've identified five stocks belonging to high-quality companies that look poised to disappoint shareholders.

What goes up, must come down
I evaluated the stocks in the S&P 500 based on their price-to-earnings multiples and prior returns on the notion that periods of high valuations/returns tend to usher in periods of low returns/valuations. That principle works best for indexes, but it also applies to stocks. The stocks in the table below boast top 20% valuations (forward P/E) and top 10% performance (one- and five-year returns). The returns remain in the top 10% even if we enlarge their peer group to include all the stocks in the Russell 3000:

Company

Competitive Advantage

5-Year Annualized Return Including Dividends

(December 2006-December 2011)

Forward P/E*

Chipotle Mexican Grill (NYSE: CMG  ) Brand 43% 41.1
McDonald's (NYSE: MCD  ) Brand 21% 18.0
Intuitive Surgical (Nasdaq: ISRG  ) Niche technology/ intellectual property 37% 34.4
MasterCard (NYSE: MA  ) Network effect 31% 17.9
Fastenal (Nasdaq: FAST  ) Distribution network 22% 32.0
S&P 500 Index -- 0% [TR Index] 11.7

Source: Author, S&P Capital IQ. *At Jan. 2.

McDonald's
McDonald's was the top-performing Dow stock in 2011, notching up a tidy 31.7% return. The Golden Arches is one of the great American brands and a terrific business. The company also has one of the best records in terms of dividend growth and consistency -- the stock currently yields an appetizing 2.8%. All these things will quite naturally endear investors to the stock, but -- you knew it was coming -- 18 times forward earnings for a mature business is a bit rich for my blood. McDonald's was a great buy at any point from January 2001 through 2005 as a turnaround stock. That bird has flown, and it is no time to (re)discover McDonald's. 

Chipotle Mexican Grill
Like McDonald's, Chipotle has created a powerful brand based on the convenience and the consistency of its product; hardly surprising, since it was spun out of the former. Unlike its parent, Chipotle's image is associated with healthful, high-quality ingredients. Chipotle's model is tried-and-tested -- the key is execution and this Mexican eatery has delivered, richly rewarding its shareholders in the process (43% annualized return over the past five years). Investors must be extrapolating those returns out into the future for them to pay 41 times forward earnings for the shares. At that price, I think this restaurant stock could leave them with a painful indigestion, or a ho-hum meal, at best.
 
MasterCard
The payment card processing industry is an oligopoly and MasterCard is one of the twin pillars of the industry (along with Visa). De-mutualized from a consortium of banks, MasterCard has performed like a champ since its 2006 IPO, smashing the index. Those returns are partly attributable to solid growth (historical and prospective) and partly to undervaluation at its launch. That discount no longer exists and investors shouldn't expect to earn premium returns from this point forward.

Fastenal
Fastenal sells industrial and construction supplies on a retail and wholesale basis. With more than 2,500 locations, the company has a terrific distribution network and is well-positioned as the industry consolidates. This is a very good business that deserves a premium price-to-earnings multiple compared to the broad market, just not as large as the one it enjoys now (32 times vs.12 times for the market).

Intuitive Surgical
The folks at Motley Fool Rule Breakers won't agree with the inclusion of Intuitive Surgical. Who can blame them? This manufacturer of advanced surgical systems is one of the "core" stocks of The Motley Fool's growth stock service, for which it has generated huge returns as a four-time pick. Color me skeptical, but I don't see Intuitive Surgical repeating the same feat over the next five years. In fact, at 34 times forward earnings and on the back of a 70%-plus return in 2011, I expect it to underperform the Nasdaq this year.

Last thoughts and more ideas
If you originally bought these stocks at a discount to their intrinsic value, it may be rational to continue holding them in your portfolio even if you think their current prospects are simply average or even below-average. If you are a long-term investor, you may consider that well-bought high-quality businesses are worth owning through periods of mediocre returns. After all, you can be relatively confident that the return over your holding period will beat the market and selling the shares incurs costs and the risk associated with having to reinvest the funds. In that case, you can focus on the stocks you want to add to your portfolio rather than ones you want to get rid of.

For another idea, The Motley Fool's chief investment officer has identified his No. 1 stock for the year. Find out which stock he likes in our brand-new free report: "The Motley Fool's Top Stock for 2012." Just click here to access the report and find out the name of this legendary company.

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio. You can follow him on Twitter. The Motley Fool owns shares of MasterCard and Chipotle Mexican Grill. Motley Fool newsletter services have recommended buying shares of McDonald's, Chipotle Mexican Grill, and Intuitive Surgical. 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.


Read/Post Comments (21) | Recommend This Article (32)

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 January 06, 2012, at 6:05 PM, Seriousadvisor wrote:

    I completely disagree with your views on MCD.

    This stock is expected to increase earnings by more than 10% this year. It is called the gift of a lifetime. Goes up every year.

  • Report this Comment On January 06, 2012, at 7:24 PM, burr0081 wrote:

    I agree with Seriousadvisor on MCD. At 18x forward earnings, it's certainly not cheap, but great companies rarely are. Also, it's hard to call such a reliable performer with a commitment to returning all FCF to shareholders overvalued at the current levels. I can see market perform over the next 5-10 years, but it's hard to see it underperform from a total return perspective.

  • Report this Comment On January 06, 2012, at 8:57 PM, AlphaDoc wrote:

    MCD is an incredibly durable company that is resilient to economic downturns. They're continuing to revitalize and develop the brand. Amazing stock to own long-term.

  • Report this Comment On January 06, 2012, at 9:31 PM, Dekabrist wrote:

    MCD is reinventing itself - new restaurant designs, new menus. I see only upside with a company that, while a stalwart, has also become uber innovative. See also this article:

    http://www.streetinsider.com/Analyst+Comments/Dont+Be+Fooled...

  • Report this Comment On January 06, 2012, at 9:51 PM, chopchop0 wrote:

    Agree with the above posters. Mcd, and ma, are high quality businesses with recognized brands and stellar earnings growth. they are full of moat with valuations that reflect that

  • Report this Comment On January 07, 2012, at 3:24 AM, BBLBBD wrote:

    The McD analysis seems a bit light. Was the global potential considered in that opinion ?

  • Report this Comment On January 07, 2012, at 5:37 AM, PhilipCohen wrote:

    What, no mention of eBay disappointing investors?

    Scott Thompson abandons the struggling eBay for the struggling Yahoo!

    Oh, Scotty, why? Why? Why?

    Well, obviously, Scotty could see the “V.me” iceberg ahead and decided to jump overboard before the tired old scow, eBay, hit that berg—a very smart move, and ...

    “Study Sees PayPal Adoption Down Among Multi-Channel Merchants

    “Twenty-two percent of EPIS merchants who had accepted PayPal on their own websites and off-eBay stores in October 2010 stopped accepting PayPal as a payment method on those sites in October 2011.

    “There were 19% more merchants who accepted credit cards on their own websites and stores in October 2011 than in October 2010.”

    http://www.auctionbytes.com/cab/abn/y11/m11/i21/s02

    And, Visa is to launch its new online payments gateway “V.me” this year. The idea is similar to that offered by PayPal: you upload details of your payment cards to Visa—even if they're not Visa-branded—and Visa will process the payment—directly with your banker—without revealing your card details to the merchant. So, the use of such a “professional” system should reduce the risk of online credit card fraud on both payers and payees to virtually zero.

    Off-eBay online merchants will be able to free themselves from the most unprofessional, parasitic, unscrupulous and “clunky” PreyPal. And, undoubtedly, PreyPal will then atrophy back to it’s mandated use on the eBafia marketplace only, from whence, without its mandated use thereon, PreyPal would never have had the success that it has had. Unfortunately, there is no relief in sight for on-eBay merchants.

    But, be in no doubt that, except for its mandated use on whatever will be by then left of the Donahoe-atrophied eBay Marketplace, the clunky PreyPal will elsewhere be quickly buried by Visa’s professional online offering, “V.me”, once it is up and running this year. Thereafter, as eBay continues to sink lower and lower in the water, so will PreyPal.

    And, as for PreyPal’s projected move into EFTPOS at B&M. Pure science fiction—“Beam me up Scotty”.

    Then, there is that other little problem of corporate image: the eBafia and PreyPal have become the two most despised commercial entities on the planet, even more hated than “the banks”, and that has taken some doing.

    No more underpinning of eBay’s sagging bottom line by the clunky PreyPal. What is the “eBafia Don” to do now? Maybe, if Mittless Romney wins the GOP nomination we can hope that he will pick as his running mate his fellow “Pain from Bain”, the headless turkey, John Donahoe. Donahoe’s nearing the completion of his destruction of the eBay marketplace and so he should soon be looking for an even bigger challenge.

    So, apparently Scott Thompson is smarter than we thought; after all, he would know the real situation at PreyPal and he undoubtedly recognises that the clunky PreyPal is on the cusp of commencing its journey down the gurgler, and he is jumping off the tired old “eBay” scow before it finally goes submarine.

    “PayPal will become bigger than eBay in the next 3-5 years”—John Donahoe, eBay Analyst Day, 10 February 2011

    Notwithstanding his obviously delusional mental state, eBay’s chief headless turkey has got that right: undoubtedly PreyPal will be bigger than eBay soon, but it won’t be because PreyPal has gotten any more successful, just the opposite—Visa’s V.me will see to that; it will be because the eBay “house of cards” has finally imploded.

    And, who but a total idiot would invest in a PreyPal IPO now?

    It appears that Donahoe genuinely was surprised by Thompson’s departure. Who then will take charge of PreyPal? Surely, only a fool would take charge of this clunky entity now. Regardless, the real question now is, when is the eBafia Don also going to abandon ship, or be thrown overboard by the owners of the ship when they finally wake up to the fact that all along they have had “Captain Queeg” at the tiller?

    Hang on, apparently eBay has found a fool to take charge of PreyPal ...

    “Ebay Boss John Donahoe To Serve PayPal’s Interim President”

    http://techcrunch.com/2012/01/04/paypal-announces-ebay-boss-...

    “PayPal claims PayPal Is Not a Payments Processor!”

    http://forums.auctionbytes.com/vbulletin/showthread.php?t=24...

    eBay / PayPal / Donahoe: Dead Men Walking.

  • Report this Comment On January 07, 2012, at 1:56 PM, wjcoffman wrote:

    How did this list of companies look at the beginning of each of the past five years?

    Is there an article that lists companies each of the past 5 years using the same criteria and how they did the following year?

  • Report this Comment On January 07, 2012, at 2:11 PM, henjo wrote:

    You Have to be kidding about ISRG. It seems like they add new procedures to be done robotically every time we turn around. There's NO end in sight.

  • Report this Comment On January 07, 2012, at 6:02 PM, mikecart1 wrote:

    I agree with McDonald's. I've been out of the country a few times in 2011 and I saw YUM is outshining MCD. Most people in Asia don't know what McDonald's is but ask them about Pizza Hut or KFC and they smile :o]

    MCD can reinvent itself all it wants. Outside of breakfast food, they still stink in terms of hamburgers and chicken. For hamburgers, Burger King owns. For chicken, Chick-Fil-A owns. McDonald's is great if you want to eat food that is over half chemicals. How else does a value meal laid out in the open for weeks and months still look the same after all that time. Preservatives is what MCD is great at. YUCK!

  • Report this Comment On January 07, 2012, at 11:29 PM, PaulChristenson wrote:

    The comments about MCD being too rich sound vaguely similar to people to said the same about IBM back in the 60s...:)

  • Report this Comment On January 08, 2012, at 4:35 PM, NotJesseL wrote:

    I disagree with the conclusions on ISRG. Its still a relatively small company and past excellent performance does not guarantee poor future performance.

  • Report this Comment On January 08, 2012, at 4:57 PM, jrj90620 wrote:

    McDonalds delivers small product sizes at continually higher prices.Recently saw the filet of fish sandwich(a tiny sandwich,with only fish and cheese),selling for $3.59.I remember buying larger ones back in the 1960's for .35.Going to be hard to maintain sales growth and margins as inflation heats up this year,forcing consumers to watch how they waste their money.

  • Report this Comment On January 09, 2012, at 11:24 AM, TMFAleph1 wrote:

    <<Its still a relatively small company and past excellent performance does not guarantee poor future performance.>>

    No-one said anything about a *guarantee* of poor future performance.

  • Report this Comment On January 09, 2012, at 11:26 AM, TMFAleph1 wrote:

    <<There's NO end in sight.>>

    Yes, and trees can grow to the sky.

  • Report this Comment On January 09, 2012, at 11:28 AM, TMFAleph1 wrote:

    <<Is there an article that lists companies each of the past 5 years using the same criteria and how they did the following year?>>

    No, but that *would* be interesting data. Unfortunately, I don't think Capital IQ stores series of forward P/E multiples that extend much beyond a few months.

  • Report this Comment On January 09, 2012, at 11:32 AM, TMFAleph1 wrote:

    <<The comments about MCD being too rich sound vaguely similar to people to said the same about IBM back in the 60s...:) >>

    Have you taken a look at IBM's performance during the 1970s?

    http://finance.yahoo.com/echarts?s=IBM+Interactive#symbol=ib...

  • Report this Comment On January 09, 2012, at 11:46 AM, OKwarrior wrote:

    So, your thesis is, "All companies whose stock excels will come back to the mean. Therefore all winning stocks from 2011 will be less than stellar in 2012." Hmmm, I would have to see this modelled and proved before I "buy" in.

  • Report this Comment On January 09, 2012, at 3:39 PM, Etrade07 wrote:

    how many burritos can one eat? most of the time u need to take an enima afterwards...

  • Report this Comment On January 10, 2012, at 12:13 AM, TMFAleph1 wrote:

    <<All companies whose stock excels will come back to the mean. Therefore all winning stocks from 2011 will be less than stellar in 2012.>>

    Nowhere do I pretend that this applies to *all* stocks. In fact, I can say with certainty that it will not apply to all stocks. I reason in probabilistic/ statistical terms -- which is why I said this methodology is more reliable for indexes than single stocks.

    Furthermore, why do you reduce the model to a single factor, when it is clearly a two-factor model?

  • Report this Comment On January 13, 2012, at 1:18 AM, OKwarrior wrote:

    I guess I missed something. What are your "2" factors? A high 5 year total return is going to closely correlate to a high forward P/E in > 75% of stocks. Don't you need to have another factor to track to create a valid filter? I might suggest a value based number.

    I agree that this is much more reliable for an index, but the tone of your article suggests that the holder of these 5 stocks should be doing more than just taking some money off the table. My impression was that you were suggesting it was time to SELL!

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