By Philip van Doorn, MarketWatch
Getty Images, Bloomberg
After four straight days of market declines, with no way of knowing how long the coronavirus will stifle the world economy, investors are understandably thinking about safety. But the notion that shares of big consumer-staples companies are the safest plays is easily turned on its head.
“The valuations on anything ‘low-risk’ are really stratospheric, and that creates risk,” according to Charles Lemonides, founder, chief investment officer and portfolio manager at ValueWorks LLC, an investment-management firm with $197 million in assets under management and based in New York.
The risk of ‘low-risk’
During an interview on Feb. 25, Lemonides named Clorox /zigman2/quotes/206443229/composite CLX -1.20% , Church & Dwight /zigman2/quotes/203816376/composite CHD +2.08% and Procter & Gamble /zigman2/quotes/202894679/composite PG +0.59% as examples of venerable consumer-staples companies with high stock valuations.
As this table shows, forward price-to-earnings valuations have stretched over the past year. Before the four-day decline that began on Feb. 20, the S&P 500’s /zigman2/quotes/210599714/realtime SPX -1.51% forward P/E valuation was at its highest level since May 2002.
|Company||Ticker||Forward P/E ratio||Forward P/E ratio - year ago||Total return - 1 year through Feb. 25|
|Church & Dwight Co.||27.9||26.5||16%|
|Procter & Gamble Co.||23.7||21.6||25%|
Lemonides said that if an investor is starting out at these high valuations, “if everything goes right, you may not lose money in a year and a half, but if anything goes wrong ... you can go to 20 times earnings from 25, and that is a big decline.”
Things that can go wrong include “a hiccup in earnings,” increasing costs or capacity constraints, he said.
I do not know what to do about [the coronavirus] as an investor, except to hold securities that will turn out fine regardless of what happens.
Charles Lemonides, founder, chief investment officer and portfolio manager at ValueWorks LLC
Lemonides summed up two risks for expensive consumer-staples stocks:
• Earnings decline because of a specific problem. Kraft Heinz /zigman2/quotes/203625533/composite KHC +2.76% is an excellent, if extreme, example. The stock declined steadily from June 2017 through May 2019 as the company struggled to adjust to changing consumer tastes. The stock now trades for 11.4 times consensus earnings estimates among analysts polled by FactSet, after trading for a forward P/E as high as 27.8 in April 2015.
• Earnings become lumpy. “You can go from a perceived very steady earnings stream to a bumpier stream, and the multiple goes from 25 to 16 or 13. So trying to find safety in those names is a very risky strategy,” Lemonides said.
The ValueWorks hedge fund run by Lemonides has a short position in Church & Dwight. Lemonides said he had previously shorted Clorox when it traded for 29 times forward earnings, and covered the position at 22 times earnings.
Coronavirus, other unknowns and better defense
Lemonides called the coronavirus a “tremendous wild card” for investors. It’s easy to point out that the flu infects millions of people each year. The Centers for Disease Control and Prevention estimate that in the U.S. alone, the flu has led to between 9 million and 45 million illnesses and between 12,000 and 61,000 deaths annuall y since 2010.
Not to make light of the coronavirus tragedy, but those flu numbers dwarf the coronavirus infection and death counts that are causing so much disruption right now. But the quick spread of the virus and the resulting measures being taken have caused a decline in production, especially in China. We simply don’t know how long this will continue or how dramatically it will affect particular companies.
“I do not know what to do about it as an investor, except to hold securities that will turn out fine regardless of what happens,” Lemonides said. He cited stocks he believes are set up for good returns over the next two years for different reasons: