It's been an awful start to the year in the markets; in fact, 2022 is among the worst on record so far, with growth stocks struggling especially hard. Investors are scared, and in many cases fleeing to safety in defensive companies. With the NASDAQ and S&P 500 down double-digits since January, chocolatier The Hershey Company (HSY 1.63%) has been up 14% and an impressive 34% over the past twelve months.
But investors should try to skate to where the puck will be, not where it's already been. Here's why investors should consider looking elsewhere for their next investment.
The stock's valuation is too rich
Hershey is a dividend stock, and one that is regarded highly by the investing community. The company sells some of the most popular confectionery brands in America, including Hershey's, Almond Joy, Reese's, and snack brands like Skinny Pop. People have enjoyed sweets for centuries, so Hershey's business has thrived for generations. Management has paid and raised a dividend for the past 12 years.
The company's solid fundamentals and consistent performance have earned it a respectable valuation from the market; the stock's median price-to-earnings ratio over the past decade is 18. However, the stock trades at a significant premium today, with a P/E of 28.
Investors need to determine why a stock might be trading so far from its historical norms. Is there a fundamental change in the company? Or is the market simply acting irrationally?
Hershey has grown revenue by 4% per year for the past decade and averaged almost 5% growth over the past three years. Earnings-per-share (EPS) growth has slowed down some, from a 10-year average of 10% to 8% annually over the past three years. There have been no significant acquisitions since 2018, when the company paid $420 million for Pirate Brands snack line. It doesn't seem that fundamentals are driving Hershey's stock price higher.
When "safe" isn't so safe
So why might Hershey stock be doing so well? Investors are scared right now. News network CNN tracks investor sentiment with its "Fear and Greed Index." It's bordering on "extreme fear" as I write this, which shouldn't be a shock. Many growth and technology stocks have gotten battered over the past year, and the major U.S. indexes have recently begun to tumble.
Psychologically, the emotional response to pain is far greater than pleasure. In other words, investors hate losing money more than they enjoy making it. Investors are probably moving money into defensive companies like Hershey, businesses that won't blow you away with growth but help investors sleep better at night.
The problem with this is that the tide will likely turn at some point. Markets often move in "cycles," and growth stocks will become popular again as fear recedes. Investors' confidence in growth stocks will return, and money will flow out of these defensive companies.
I left my crystal ball at home, but I would think that a company trading at such an elevated valuation without fundamentals supporting it will eventually revert to its historical norm. That could mean a sizable slide in Hershey's case, because the stock's valuation sits 55% above it.
Nobody knows the future, and Hershey's stock could continue holding up for months, even years, for all I know. However, investing is about looking ahead and using the information available to you to make the best decisions for your portfolio.
Hershey is expensive compared to its historical norms, and there doesn't seem to be fundamental support that will prevent this from changing in the future. Investors may view Hershey as a safety net today, but I don't feel as confident about that staying the case.