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My 5 Worst Stocks in the S&P 500

I can think of a million things to do on a Friday night -- apparently one of those things is to run stock screens on companies that comprise the S&P 500 index.

With the stock market in rally mode and the S&P 500 hitting levels it hasn't seen in three-and-a-half years, I'd be lying if I said I wasn't concerned about stock valuations getting ahead of themselves. Certain sectors are still so far from their highs (e.g. financials) that a rally seems reasonable. But make no mistake about it -- the S&P 500 is in no way, form, or shape, cheap.

With an average P/E ratio over the last 131 years of 15.8, the current P/E of 22.5 still sits well ahead of the norm. In fact, the S&P 500 hasn't been below the mean in 21 years!

Clearly there are factors that have driven the S&P 500 higher over time. The technological revolution over the past two decades has completely transformed the way we do business. In addition, accessibility to information for the layman has gone from reading a newspaper to point-and-click convenience in just 20 years.

If anything though, the above chart gives an undeniable visualization that allows you to see where the greatest valuation bubbles through history have occurred.

It's with this in mind that I set out to find the weakest links in the S&P 500. I singled out five stocks that I feel simply don't have what it takes to stand the test of time. If the S&P 500 continues to trade higher (and trust me, despite being a realist, you'll get no complaints from me if that keeps happening) I would expect investors to become increasingly skeptical of these five companies.

Sears Holdings (Nasdaq: SHLD  )
Sears could very well be the worst company in the S&P 500 and is one of the few whose survival is actually in question.

Late last year, the once-iconic retail chain outlined a plan to close up to 120 Sears and Kmart locations as it struggles to control costs and return to profitability. It has seen its debt balloon from $3.5 billion to $4.6 billion in just one year, while its cash balance has dropped by more than half to just $632 million. With sales falling a mind-numbing 19 consecutive quarters, Sears has failed to control its inventory and drive interest in the few remaining brand names that matter (e.g. Craftsman and Kenmore). It could just be a matter of time before Sears finds itself in the same company as Eastman Kodak and American Airlines.

Gap (NYSE: GPS  )
If same-store sales declines were fashionable, then Gap would be a trendsetter. The clothing company lost its pizzazz more than a decade ago and simply hasn't been able to rekindle the spark that made it one of the best performers of the 1990s.

Primary to Gap's downfall has been easier access to cheaper and potential chicer clothing choices. Gap's inventory has either been not what customers want or it has simply been too expensive relative to what consumers can get at Target, Wal-Mart, or numerous mall-based retailers. Gap's management team has also been slow to respond to consumers' changing demands for better values and different styles. Stubbornness from the top is driving this trendsetter into the ground and I'd highly recommend parting ways with Gap before it splits at the seam.

Capital One Financial (NYSE: COF  )
I've picked on Capital One a lot over the past year, but with good reason. Capital One, more than any other bank, has very large ties to the credit market. More than 80% of the company's revenue is derived from its credit card business which I feel places it at significant risk if delinquencies begin rising.

Unfortunately for Capital One shareholders there isn't just one end-all reason why delinquency rates would rise. As I see it, the myriad possible causes for rising delinquency rates include falling housing prices, high unemployment rates, alt-a mortgage resets, and European macroeconomic uncertainty. I'm sure there are other reasons I haven't even considered, but the primary takeaway is that Capital One is far too levered to the credit markets and that could wind up coming back to bite it in the behind sooner rather than later.

First Solar (Nasdaq: FSLR  )
Solar does appear in the cards for the future, but the stark reality as of now is there's simply too much supply and not enough demand to justify many of these solar companies' valuations even with many of them down more than 80% off their highs.

First Solar significantly reduced its revenue guidance in late December and the sector still hasn't shown any signs of solar panel prices stabilizing. It could easily take years before the oversupply in this sector is sorted out and it's quite possible that solar's biggest proponents up until now -- Germany and Italy -- could be down for the count after austerity measures are firmly in place and these countries fight just to stay out of a prolonged recession. I cautioned investors in December that heavy insider selling coupled with rapidly falling earnings estimates were a tell-tale sign to sell and I'm sticking by that assertion.

Altria (NYSE: MO  )
Much like Budweiser has been replaced as the King of Beers by light beers, I feel Altria is fighting a losing battle against the trend toward a healthier consumer.

Altria has already felt the pangs of this trend by laying off about 15% of its workforce in response to slowing sales of its flagship Marlboro brand and increased competition from discount cigarette brands Maverick and Pall Mall. The legal prospects for Altria also look grim. The U.S. is arguably the most stringent country to operate a business in, and with no diversification outside of the U.S. in terms of cigarette production it could see its business slowly crushed by lawsuits. The addition of large health warning labels on cigarette packaging this year is not bound to help its cause either. Even with investments in SABMiller, I don't see a bright future for Altria and think shareholders investing now are getting just the butt.

Foolish roundup
With 500 companies in the S&P 500 there are bound to be losers. These five represent my choices for the worst investments in the S&P 500 and shareholders in these stocks should be cautious moving forward, especially if investors like me continue to grow skeptical of the S&P 500's rising P/E ratio.

What's your pick for the worst company in the S&P 500? Share it in the comment section below and consider adding these five stocks to your free and personalized watchlist.

Also, to avoid the pitfalls of poor investments, consider downloading your copy of our latest special report, "11 Rock-Solid Dividend Stocks," in which our analysts handpick a handful of companies that should do well regardless of whether the economy is booming or in a recession. Best of all, this report is completely free for a limited time!

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He's always looking for the proverbial needle in the haystack . You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of Apple, Gap, Wal-Mart Stores, Altria Group, and First Solar. Motley Fool newsletter services have recommended buying shares of Apple, Wal-Mart Stores, and First Solar, as well as creating a bull call spread position in Apple and a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 that'll always be best of breed.

Read/Post Comments (10) | Recommend This Article (40)

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 February 07, 2012, at 4:20 PM, sernow wrote:

    I think you should make it much clearer that you are not calculating p/e the traditional way (either trailing 12 months or forward 12 months), but are using the Shiller p/e that is the price to average earnings for the past ten years. Using the traditional methods would disprove your thesis.

  • Report this Comment On February 07, 2012, at 5:00 PM, financeguy85 wrote:

    I generally value statistics more than stories. Placing Altria in this group seems like an error in judgment. Words like 'health-conscious consumers', 'litigation', and 'government regulations' might make for an exciting article but are in fact just words. Words that have been used as a reason to avoid Altria for decades. I have owned the stock for many years and from my perspective, things are just fine.

  • Report this Comment On February 07, 2012, at 7:29 PM, sikiliza wrote:

    @financeguy85 - I agree - Altria has continued to beat the skeptics for a long time and is going to be around for a while. For crying out aloud, all that sugar in Coke's products is not healthy at all yet people still gulp down sodas at a faster rate than before.

  • Report this Comment On February 07, 2012, at 8:21 PM, jmoule wrote:

    Now the question is how much is already baked into the price of these stocks.

  • Report this Comment On February 07, 2012, at 8:27 PM, tkell31 wrote:

    Did you really just compare sugar to nicotine? So you must think nicotine is in almost everything we eat and drink just like simple carbohydrates i.e. sugar. Oh, and how many people drink 20 cokes a day? That being said as long as big T can keep getting people hooked on nicotine they will be okay.

  • Report this Comment On February 07, 2012, at 8:34 PM, Tsharp1947 wrote:

    I bet the tobacco stocks, including MO, outperformed Motley Fool (again) last year!

  • Report this Comment On February 08, 2012, at 1:36 AM, weatherman2011 wrote:

    Check out EK as one of the worst stocks. I finally sold all I had left for $0.391.

  • Report this Comment On February 08, 2012, at 1:52 AM, mansourg54 wrote:

    What bother is the phrase "healthier consumer in the US". This health attitude is worldwide and not just in the US. But PM and BTI are flourishing. If we follow the above arguement we end up eating only cabbage and caulflower because evrything else has either salt, fat, sugar or all and all are a health hazard. If people live healthier then many drug and pharmaceutical companies should close the door, per the above arguement.

    MO shares have more than doubled since 2009 and has increased its dividends by 20%. The drop in cigarette sale is caused by the bad economy. 95% of all lawsuits have been won by MO. The drop in cigarette sale is upset by increases in smokless tobacco, wine, cigars an financial leases.

  • Report this Comment On February 08, 2012, at 8:34 AM, DCUDFlyer wrote:

    "@ mansourg54 - great points

    "...healthier consumer in the US"

    Based on what? Good thing you probably stayed away from MCD as well since they've really been beaten down....

  • Report this Comment On February 08, 2012, at 3:21 PM, TMFPennyWise wrote:

    Your observations about GAP, Inc. (GPS) are interesting and certainly widely held but I believe management is taking the bull by the horns and is making a difference.

    I look for a turn around this year as it closes domestic stores and continues its push into Japan, China and other parts of Asia. And then into India. Its new(er) stores called 'Athleta' offering athletic and yoga wear compare favorably to Lululemon (many Athleta items are made in the same factories but are sold for much less by GAP. Inc.) and this division is experiencing a growth curve too. Also word is 'spring' GAP inventory by the new designer is flying off the shelves so that's encouraging too.

    It remains to be seen whether it can beat your screening analysis though. Hopefully it will. A good retail play to keep an eye on.

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