Editor’s Note: The original article used incorrect stock symbols, this version has been corrected. Motley Fool apologizes for the error.
When the stock market is doing very well, as it is currently, it’s easy to throw valuation to the wind. Stock-picking becomes easier and easier when the markets are in a seemingly unstoppable bull market stampede, because as the saying goes, a rising tide lifts all boats.
However, investors need to be as focused as ever to find stocks that will not just do well when the market goes up, but also have the capacity to protect investors against the inevitable next market downturn. This is called a margin of safety, which some stocks simply don’t offer in the current market environment.
With the markets setting new historic highs, there now appears to be a glut of stocks that are trading for rich valuations. Some stocks will prove dissenters wrong by growing their sales and profits fast enough to justify their multiples, but in many instances, investors are being set up for disappointment. With that in mind, here are a few stocks that lack meaningful margins of safety, which investors would be wise to keep an eye on going forward.
Modest growth, with valuations that are anything but modest
These companies’ underlying financial performance, while solid, is more indicative of mature value stocks than of growth stocks deserving of lofty valuations. For example, McKesson Corporation (NYSE:MCK) is a $26 billion health care giant with an equally impressive valuation profile.
There’s no doubt that the company is financially successful and highly profitable. To that end, McKesson Corporation (NYSE:MCK) booked $122 billion in revenue last year. While impressive, the company saw no growth in 2012 revenue year-over-year. Ditto for profitability—McKesson Corporation (NYSE:MCK) earned $5.59 in diluted EPS last year, flat versus 2011.
That hasn’t stopped McKesson Corporation (NYSE:MCK)’s stock price from rallying. The stock has returned more than 20% just since the beginning of this year. As a result, McKesson Corporation (NYSE:MCK) now trades for 21 times earnings and provides a paltry dividend yield of just 0.8% annualized.
Ditto for a different health-care stock, Stryker Corporation (NYSE:SYK), which holds a $25 billion market cap, comparable to McKesson Corporation (NYSE:MCK).
Stryker Corporation (NYSE:SYK) exchanges hands for nearly 21 times trailing earnings, despite full-year 2012 results that were unspectacular. While Stryker Corporation (NYSE:SYK) did book 4% revenue growth, the company’s diluted earnings per share actually fell nearly 2%, largely the result of significantly higher expenses.
There wasn’t a whole lot to brag about in the company’s first-quarter report, either. Net sales inched up 1% and diluted earnings per share grew by just 4% year over year. Yet Stryker Corporation (NYSE:SYK)’s stock price has surged anyway, rising 22% to begin 2013.