4 Stocks I Would Approach with Caution

Rudy Martin

Did you see cute little Gracie in the feel-good Cheerios commercial during the Super Bowl? The young girl cleverly negotiates a puppy in exchange for peaceful coexistence with a forthcoming baby brother.

I have different plans for Gracie’s "employer," packaged food giant and Cheerios-producer General Mills (GIS). Last week I nominated General Mills as a potentially defensive stock for 2014.

My new proposal will let steady-and-dependable GIS elevate its profits 61% in one fell swoop! Here’s how:

  • Immediately discontinue its $895 million advertising and media expenses, including Gracie’s Cheerios ads, and
  • Eliminate $238 million in research and development costs.

These two simple moves would fatten the General Mills bottom line from $1.86 billion to $2.99 billion!

Speaking of Super Bowl ads, I can lift net earnings at Anheuser Busch InBev (BUD) upward by 57 percent. All they have to do is fire the Clydesdale horses as well as those Bud Lite stretch-limo Super Bowl spots. They are among the $5.44 billion sales, marketing, research and development expenditures BUD can do without.

And while I’m at it, I could more than double the $4.68 billion net at Eli Lilly & Co (LLY) by immediately halting the $5.53 billion it devotes annually to R&D.

See my point?

Censored: What You’d Never See Aired

During Super Bowl XLVIII

Tthe 100 million people who watched the Seahawks trump their way to victory will never know what they couldn’t see during the game.

In fact, there could be a deliberate plot to censor this anomaly.

While 100 million people will remain clueless … I will pull the curtains right now and show you a video you could NEVER see while the $4 million halftime ads were blaring on your T.V. screen. Click here to watch it now.

Internal Sponsorship

I don’t really think General Mills, BUD or Lilly should slash programs essential to their futures. I’m trying to demonstrate how indiscriminate cost-cutting to boost short-term profit margins can seriously jeopardize a company’s longer-term survival.

Rising profit margins alone don’t tell me much. I’m always curious about why profit margins rise. Serious investors know the importance of examining company reports in detail!

We see this in the present fourth-quarter earnings season. In recent years, it seemed almost "automatic" for a company’s shares to bounce when profits exceeded analyst expectations. Likewise, when earnings fell short of "the consensus," stocks would usually tank.

This reliable pattern seems to have changed. Now we see companies beating earnings estimates, but then falling anyway when scrutiny reveals undesirable items in the reports.

In other cases, encouraging data hidden beneath the surface led to higher share prices even though the headline numbers fell short of expectations.

Google (GOOG) is a good example. The firm reported fourth-quarter adjusted earnings-per-share of $8.62, well short of the $12.26 consensus estimate. Yet closer examination showed a 31% year-over-year gain in paid clicks. Google’s $16.86 billion revenues slightly beat the $16.75 billion estimate.

The result: Google shares jumped to a new all-time high even though the company missed its estimated earnings by a mile!

On the other hand, even though Apple (AAPL) announced record quarterly revenues and trounced analyst expectations on both the top and bottom lines, investors pounded its shares due to iPhone unit sales and weak forward guidance.

Considering all the uncertainty 2014 has thrown at investors, this trend of digging below the headline numbers should become the norm. I’ve been poking into the hidden corners of corporate reports for decades, and continue to do so for Global Trend Trader subscribers.

Now is no time to relax your standards and assume that 2013-like gains will continue to roll in. Every investor should start probing deep below the surface in every investment decision.

For example, the four well-known companies in the table below might seem like tempting investments, but some of the "surface" data raises caution flags at me. Among my concerns:

VALUATION ISSUES — All are pricey on their basic valuation measures. Four trade north of 20 times earnings and all have been trading at more than three times book value. Accenture (ACN) is just shy of 11 times net asset value.

You also have to wonder if a supermarket chain — even a high-end one like Whole Foods Market (WFM) — is worth 40 times earnings and more than four times book value.

POTENTIALLY OVER-AGGRESSIVE COST-CUTTING — The four-year EPS annual growth rate for these companies significantly exceeds their compound annual revenue growth rate. This can happen when a firm reaches critical mass where efficiencies of scale result in lower expenses. Operating leverage and/or financial gearing could also explain the divergence.

But while these factors can amplify earnings during economic expansion, they also magnify losses in troubled times. Profit margins (see the bottom two rows of the table) have expanded as earnings outpaced revenues.

I would want to scrutinize these to make sure future growth isn’t being sacrificed to enhance current quarterly results.

PROJECTED SLOWDOWNS — The consensus of analysts tracking each of the four companies shows annual earnings growth rates will moderate over the next five years.

While three of the four shows projected double-digit annual growth rates (Accenture is just slightly below that threshold), the direction and the magnitude of the projected slowdowns deserves investigation.

I’m not saying Accenture (A), CarMax (KMX), Estee Lauder (EL) and Whole Foods (WFM) are bad buys. Microscopic examination of these four might conclude that some — or even all of them — are appropriate for certain investment portfolios.

My point is that self-guided investors should thoroughly examine every stock, just as I do for my Global Trend Trader subscribers. That’s especially true when a company has issues like those in the table.

Any stock I recommend will be there only because I scrutinized it in detail under by analytical microscope.

My portfolio selection process uses multivariate computer models to probe valuation, growth, stability and safety as well as other quantitative measures.

I’ve found that most every stock has "issues" to resolve before I add it to one of my portfolios. Doing so is hard, intense, round-the-clock work. I’ve enjoyed that work for all my professional life, and the benefits go to my investment clients and readers.

Happy Trading!

Rudy

P.S. The Dow hasn’t seen a January this bad since 2009 … when stocks were still reeling from the financial crisis.

Now, years of quantitative easing … bank bailouts … and artificially low interest rates have created a cancer in our economy. They have brought us to the precipice of another crash that could be bigger than the Tech Wreck and real estate bubble combined!

That’s why I’m urging you to read Tony Sagami’s urgent new investor report: "The Greatest Threat to Your Retirement." It could be the best financial decision you make all year. Don’t wait. Click here to read it now.