There's no two ways about it, the last 16 months have been challenging for investors. All three major U.S. stock indexes entered a bear market in 2022, with growth stocks getting hit especially hard. But the volatility equities experienced last year may be about to ramp up once again.
Two weeks ago, the minutes from the Federal Open Market Committee's (FOMC) March meeting contained the dreaded "r" word: recession. Though numerous indicators have signaled a growing likelihood of a U.S. recession for months, the FOMC modeling a "mild recession" into its outlook for later this year is added confirmation that things could be challenging for investors over the next couple of quarters.
When things get volatile on Wall Street, everyday investors have a tendency to turn to safe stocks. By "safe stock," I'm talking about a generally profitable, brand-name, low-volatility, dividend-paying business that's been able to deliver for shareholders during uncertain times.
Unfortunately, not all safe stocks are attractively priced or are going to hold up well if the U.S. dips into a recession. What follows are five well-known safe stocks I wouldn't touch with a 10-foot pole right now.
Warehouse club Costco Wholesale (NASDAQ: COST) is nothing short of a retail juggernaut. Its size allows it to purchase items in bulk and pass along those savings to its members. Furthermore, the membership fee people pay annually to shop at Costco fuels a substantial portion of the company's operating margin.
However, Costco isn't immune to a reduction in discretionary spending during a recession. Over the past year, the U.S. personal saving rate has plummeted to levels not seen since 2008. If its members have less disposable income, there's a good chance Costco will be moving fewer of its high-margin discretionary items.
What's more, same-store sales actually declined for Costco in March compared to the prior-year period, inclusive of fuel costs and currency movements. Even excluding fuel, year-over-year sales grew by a meager 0.5%.
No matter how impressive Costco's business has been over the years, there's absolutely no reason to pay 35 times Wall Street's consensus earnings estimates when sales growth appears to be slowing down to the mid-single digits.
Out of the five brand-name safe stocks on this list, consumer staples stock Kraft Heinz (NASDAQ: KHC) is the cheapest based on the price-to-earnings (P/E) ratio. While Kraft Heinz has been a prime beneficiary of shifting food consumption habits tied to the COVID-19 pandemic, there are also two prominent red flags that make it a stock to avoid.
To start, Kraft Heinz reported a 10.4% organic net sales growth rate for the fourth quarter. Sounds great, right? Not so fast. It achieved this by raising prices by 15.2% globally, which means its volume/mix declined by 4.8%. This is pretty clear evidence that consumers are trading down to cheaper options, which isn't good news now that the U.S. inflation rate is declining.
The other big issue for Kraft Heinz is its balance sheet. Even after a $15.4 billion goodwill write-down in February 2019, the company is still lugging around $30.8 billion in goodwill, $42.6 billion in intangible assets, and $20 billion in debt. There's little financial flexibility for the company to sustain its momentum post-pandemic or reignite interest in its brands.
Even at 14.5 times Wall Street's forecast earnings for 2023, Kraft Heinz looks like a gamble.
Procter & Gamble
A third brand-name safe stock I wouldn't touch with a 10-foot pole is Dow Jones Industrial Average component Procter & Gamble (NYSE: PG), which is best-known as P&G. Although P&G recently raised its base annual dividend payout for a jaw-dropping 67th consecutive year and delivered 7% organic sales growth in the fiscal third quarter, not all is what it seems.
The problem with Procter & Gamble is that, similar to Kraft Heinz, it's relying on price hikes to do the heavy lifting. Across P&G's five core operating segments, prices were up a brisk 10% in the fiscal third quarter. Comparatively, volume collectively fell 3%, with only two out of five segments (healthcare and beauty) showing volume increases. In short, we're very likely witnessing consumers trading down to generic or store-based brands due to higher prices.
Now that we're well past the worst of the COVID-19 pandemic and the U.S. inflation rate has backed off considerably from its peak, P&G is about to discover that it lacks the tools to meaningfully move the needle. Wall Street is only expecting 1.3% sales growth for fiscal 2023, yet investors have anointed Procter & Gamble with an aggressive P/E multiple of 27. That's nowhere near compelling enough for a stock with a mediocre 2.4% yield.
Pharmaceutical giant Eli Lilly (NYSE: LLY) is another brand-name stock I'd avoid like the plague right now. While there's no question it's been the pharma name to own over the past decade, and it's had some major wins with its type 2 diabetes and cancer-drug portfolios, there are a couple of obvious reasons to steer clear of Eli Lilly.
To begin with, a sizable percentage of the company's key products aren't growing. Older diabetic medications Humalog and Humulin saw sales respectively dip by 16% and 17% in 2022, while Alimta's full-year revenue plunged 55% to $928 million on the heels of generic competition. Furthermore, the company's COVID-19 antibodies revenue fell off a cliff in the fourth quarter due to the pandemic being put in the rearview mirror.
But the real concern is the valuation. Even with a solid pipeline that should lead to additional drug launches in the coming years, investors are paying 46 times Wall Street's consensus earnings estimates for Eli Lilly in 2023 and receiving a dividend yield of just over 1% in return.
By comparison, you can scoop up shares of Pfizer, Merck, or Bristol Myers Squibb for 12, 17, and 9 times Wall Street's respective forecast earnings for these pharma stocks in 2023. Pfizer, Merck, and Bristol Myers Squibb also trounce Lilly in the dividend department, with respective yields of 4.1%, 2.5%, and 3.2%.
To be clear, Apple didn't become the largest publicly traded company in the U.S. by accident. It got there because of its highly valuable brand, its physical product and subscription-service innovation, and its unparalleled capital-return program that's seen more than $550 billion worth of common stock get purchased since the start of 2013. But even legendary stocks hit rough patches.
Prior to the launch of iPhone 14 (Apple's best-selling product is its iPhone), the tech titan was anticipating upping production. But following a weaker-than-expected launch, it canceled those plans. Even with historically high inflation as a tailwind to end calendar year 2022, Apple's sales and profits are expected to modestly decline in fiscal 2023 (the company's fiscal year ends on Sept. 30).
To make matters worse, rapidly rising interest rates have removed the cheap capital Apple had previously leaned on to repurchase its common stock. Though the business is generating more than enough cash flow to continue buying back stock, the magnitude of its buybacks could decline. That could lead to slower future earnings growth.
Apple may be the world's most valuable brand, but there's absolutely no incentive to pay 28 times fiscal 2023 earnings when the company's sales aren't growing.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Bristol-Myers Squibb, Costco Wholesale, Merck, and Pfizer. The Motley Fool recommends Kraft Heinz. The Motley Fool has a disclosure policy.