3 Dow Stocks You Should Be Selling

Source: Thinkstock

Source: Thinkstock

While the Dow Jones is trading within 2 percent of its all-time high, there are some components that have been relatively weak. Not only have they been trending downwards, but they seem to have deteriorating fundamentals. In this article I have singled out three Dow components that I believe have downside risk. The fact that they are members of the most famous market index in the world doesn’t preclude them from being overvalued, and from declining earnings and revenues. Investors are therefore encouraged to sell their positions in these companies.

1. Procter & Gamble (NYSE:PG)

This is a stock that is often cited as one of the best stable investments for conservative long term investors. It pays a 3.2 percent dividend that rises every year like clockwork, and management is perpetually buying back stock. However the company’s revenue growth over the past few years has been essentially non-existent. And it gets worse — high input costs and increased competition in the consumer products space means that the company’s margins are being compressed. While share repurchases have somewhat masked earnings declines on a per-share basis over the past several years the company’s net income has fallen from $12.7 billion to $11.3 billion.

Despite this lackluster performance the company trades at 22-times earnings. While this is essentially in line with the S&P 500 keep in mind that the S&P 500 has been growing earnings per share in the aggregate over the past several years. Procter & Gamble’s reputation has elevated the valuation, but there is little else to justify paying $81.50 per share for the company, and I think now is a good time to sell.

2. International Business Machines (NYSE:IBM)

IBM has gotten a lot of publicity recently because Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A) has been buying this stock hand over fist. The shares trade at just 13 times trailing earnings, and management has been buying back stock and raising its dividend for years. The company is a leading software services company and it is expanding into high growth areas of the technology space such as cloud computing.

Unfortunately the numbers tell a far less compelling story. The company’s revenues are declining every year — 2013 revenue fell to 2010 levels of just under $100 billion. For a while IBM has been able to mask this decline by cutting costs and increasing profits. These profits seemed to grow even faster because management bought back a lot of stock, and on an earnings per share basis, the profits seemed to be growing quickly.

But these masked the real problems at the company, and this became clear in the first quarter earnings release. Despite the share buy-backs and cost cutting measures the company finally released a lousy earnings number — net income fell by nearly a fourth, and $15 billion or so in stock repurchases couldn’t mask this decline. While investors haven’t sold off IBM shares yet I think it is only a matter of time, and $190 per share is a good exit point.

3. Nike (NYSE:NKE)

Nike is one of the faster growing Dow stocks — last quarter’s sales rose by 13 percent. Furthermore the company has been growing its sales in the double digits. Nike has a very powerful brand in the athletic apparel industry, and people all over the world are familiar with this brand and demand the company’s products. There are, however, a couple of problems.

The first is valuation. Nike trades at 25 times trailing earnings, which is quite steep. This means that the shares are priced for perfection, and if the company doesn’t execute then we can see significant downside. As powerful as Nike’s brand is brand loyalty is fickle, and there isn’t much else that draws people to Nike’s products. This leaves the stock vulnerable — we could easily see a bad quarter push Nike’s valuation down to 20 times earnings, and this means the shares have 20 percent downside. The company’s dividend isn’t very attractive either at 1.3 percent, which means that its stock has to fall a lot before value and income investors become interested.

The second is margins. While the company grew sales in the double digits last quarter profits were only slightly higher. This means that margins are compressing. Strength in the prices of cotton and rubber, as wells the high costs of maintaining the company’s products’ brand appeal are all counteracting sales growth. We already saw that the stock could fall a lot if sales growth falls — what happens if both sales growth and margins fall? We could easily see shares fall to 15 times earnings, and this means they have as much as 40 percent downside. Thus I would argue that Nike is too risky.

Disclosure: Ben Kramer-Miller has no positions in the stocks mentioned in this article.