The Dow Jones Industrial Average is flat on the year but that doesn’t mean there haven’t been some big winners. The following three stocks—Disney, Intel, and Microsoft—have all generated double digit returns, and they are trading at or near multiyear highs. Clearly this means that investors are confident in their futures. This is a result of their recent strong performances. But is this sustainable? After all there are a lot of global economic headwinds from geopolitical tensions to tepid economic growth and record low interest rates in countries throughout the world.
Let’s take a look at each of them to see if they have more room to run or if you should take profits.
The Walt Disney Company is up over 14 percent for the year. The company is hitting on all cylinders as it has released blockbuster movies while its ESPN franchise continues to thrive. Last quarter the company’s earnings per share grew by 27 percent, which is a huge jump for a mega-cap company. Furthermore investors expect this to continue—they have a $92/share price tag on the stock, which gives it another 6 percent upside.
But is this enough to justify owning the stock now? While Disney is a great company that owns fabulous brands that generate significant revenue streams for shareholders investors my want to reconsider taking a position in Disney shares. Investors are so enthusiastic because they expect the current trends to continue, but we have to keep in mind that a lot of Disney’s profit growth is coming from one-time blockbuster films. If the company experiences a couple of duds, we can really see this take a toll on earnings. Furthermore, one of the company’s biggest businesses is its theme park business. This business generates enormous revenues but it is a relatively low margin business, and if we see a recession this business can actually lose money. These points make Disney especially vulnerable to the downside, making the 6 percent upside potential seem small by comparison. I would stay away for now.
Intel has been breaking out to multi-year highs as analysts have come to the realization that the PC is not dying, at least not any time soon. As a result demand for Intel’s products is rising and so are the company’s profits. The company’s earnings skyrocketed last quarter by 40 percent, and investors are ecstatic. Still, however, the stock trades at just 16 times earnings, which is lower than the 22 times earnings that the S&P 500 trades at. With this in mind one could argue that Intel has more upside.
But there is a risk to this upside. The company is almost certainly not going to be able to grow its earnings at 40 percent per year for a long period of time. In fact this is probably a one-time event—earnings will likely flatten out or move slightly higher over the long run. This is because while the PC isn’t dying it is not thriving either. With this in mind, Intel is probably a low growth company going forward. Now this might not be such a bad scenario for a company trading at 16 times earnings, but I think the move is behind us, and we will likely see some significant consolidation in the coming months. This would be a great income stock if the company regularly raised its dividend, but since it doesn’t I’m staying away.
The Microsoft story is very similar to the Intel story, and in fact Microsoft’s 15.5 percent upswing this year can be attributed to the same phenomenon, namely that the PC isn’t dying. Like with Intel the company trades at about 16 times earnings and so it is relatively inexpensive.
But unlike with Intel, I am more enthusiastic about Microsoft’s future. First, Microsoft is a great income stockbecause management is committed to raising the dividend each year. Second, the company has a new CEO—Satya Nadella—who has already brought a new perspective to this lumbering giant, and based on the cost cutting measures we have seen thus far I think we can see additional profit growth, and even an acceleration in sales growth.
Of the three Dow winners mentioned here, this is my favorite, but keep in mind that stocks that have run up are always vulnerable to a near-term pullback.
Disclosure: Ben Kramer-Miller has no position in the stocks mentioned in this article.