Investors have long favored growth and income stocks which deliver reliable dividends and modest capital appreciation over time. But these high P/E blue chips carry risk if the price isn’t right.
In fact, it’s a common value investing pitfall to overpay for a seemingly safe and stable company. At the wrong entry point, however, defensive stocks can fail to live up to their name.
With these three overvalued high P/E blue chip stocks, a big pullback should be expected in coming months and years. These companies offer good products and have solid brands but are stock market traps given their outlandish valuations.
WD-40 Company (WDFC)
WD-40 Company (NASDAQ:WDFC) is a company that makes home maintenance and cleaning supply products. It is primarily known for its WD-40 product which protects metal from rust and corrosion, lubricates, and helps free stuck parts.
WD-40 has a strong brand. There’s no denying that. But it’s arguably not enough to support the company’s current $2.6 billion market capitalization. This makes it one of those high P/E blue chips to avoid.
The company has grown revenues from $369 million in 2013 to $519 million in 2022. That works out to a 4% annualized compounded rate over the past decade. Remarkably, it also means this barely-growing company is selling for more than 5x revenues.
It’s not just the top-line that is underwhelming. Shares are currently going for 46x trailing earnings. And those aren’t growing much either. The company earned $4.64 per share in 2018, and this only nudged up to $4.90 last year. Needless to say, this level of earnings is not usually sufficient to support a nearly $200 stock price. WD-40 is a reliable household product, but WDFC stock is not one that blue chip investors can count on at today’s prices.
Tootsie Roll Industries (TR)
Tootsie Roll Industries (NYSE:TR) is a confectionery company known for its namesake candies. It also produces brands such as Andes, DOTS, and Dubble Bubble.
In theory, investors might be drawn to a candy company. After all, famed investor Warren Buffett made a huge profit from his investment in See’s Candies. The idea of owning a strong brand in a capital-light business model while selling sugar is appealing.
That said, Tootsie Roll is not the candy or chocolate company to own. The company’s brands are not compelling to younger consumers. As a result, revenue growth has been anemic. Tootsie Roll only grew revenues from $543 million in 2013 to $687 million in 2022. That’s a compounded growth rate of just 2%, which hasn’t even kept up with inflation. Earnings and dividend growth have also been decidedly underwhelming.
Despite all these facts, Tootsie Roll shares are selling at a shocking 36 times earnings, and nearly 100x last year’s free cash flow. Simply put, the market is pricing Tootsie Roll like a high-flying growth company, despite its actual business being far from it. All these factors mean TR stock is one of those high P/E blue chips to avoid.
Rollins (ROL)
Rollins (NYSE:ROL) is a roll-up focused on the pest control industry. The firm has gradually acquired a huge number of local and regional operators in the pest and termite control fields. This process of continually acquiring more business within a fragmented industries can generate solid long-term returns.
Rollins enjoyed a particularly beneficial backdrop in recent years as a primary competitor, Terminix, ran into operational issues. Now, though, competition is picking up both from domestic rivals and foreign players such as Rentokil which are making more aggressive moves.
Meanwhile, investors are paying a huge price for ROL stock based on past results. Shares are going for more than 50 times trailing earnings and 47 times forward earnings. This is a jaw-dropping P/E multiple for a firm that has grown revenues at just 8%/year compounded over the past decade. If any sort of industry slowdown or operational issues hit Rollins, the share price could get squished like a bug.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
