At the Motley Fool, the goal is to give easy to understand, well-reasoned, actionable investment ideas for you to consider. For the most part, that translates to ideas for stocks to research further to consider adding to your portfolio.
But one of billionaire Warren Buffet's most famous maxims is that an investor should not lose their capital. A simple thought exercise illustrates why. If you buy a stock and it loses 50% of its value, it will have to double from that point onward just to get you back to break even.
While this is definitely the hope of all of us who have seen a portfolio holding plummet in value, it's often not realistic to expect a business that is worth half what it was at an earlier point to suddenly and dramatically turn it around to the point where it doubles in price.
With that in mind, here are three stocks often thought of as blue chips that many Australian investors own, or would have owned at some point. If you look through the articles I've written, I've cautioned against each of them at some point, and I believe that they are still dangerous for an investors capital.
Blackmores Limited (ASX: BKL) was the stock market superstar of 2015 that no one saw coming. Sure it had a lot going for it, with a market leading brand in Australia and several overseas markets and strong exposure to the emerging Chinese consumer.
But few thought that those attributes would lead to the company being valued at an eye-popping 63 times earnings by the end of 2015. That earnings multiple is magnitudes higher than what pharmaceutical companies that produce life-saving drugs command. And while Blackmores researches and markets products that are said to improve aspects of health and wellbeing for thousands, the simple fact is, if its products were to disappear entirely, no one would suffer medically serious health consequences as a result.
A tightly held share register, a great and easy to understand story, and a recent announcement that the company was cleverly using its brand position in China to expand into producing infant formula (another high demand area) have seen the share price rocket to unsustainable levels, and buying now would be a dangerous move. If you were lucky enough to own it, congratulations! It might be time to consider taking some profits.
BHP Billiton Limited (ASX: BHP) is caught between a rock and a hard place, but its problems are easy to simplify. In essence, it sells four products: copper, oil, iron ore and coal.
Each of those four products is subject to global supply and demand pressures. Usually, a downturn in one product is offset by moderate or strong demand in another. Currently, all four products are suffering from lower demand and higher global supply. The result – lower profits, for an extended period.
At the same time, BHP management has tied itself to a progressive dividend policy. The lunacy of this is also easy to explain. You work as a contractor. You also give away 90% of your income (coincidentally, that's also how much of profit that BHP pays to its shareholders as dividends) to family and friends.
All of a sudden, your income falls suddenly, but you still commit to maintaining the amount you give away. How do you finance this commitment? Well, either by cutting how much you invest in getting new jobs, or you borrow money from the bank. Does that course of action make sense for the contractor, or for BHP? No. Do thousands of investors and analysts pretend that it does? Yes.
Woolworths Limited (ASX: WOW) is another former blue chip that has fallen a long way. Its problems stemmed from protecting margins and profits at the expense of having competitive prices.
Aldi and Coles ruthlessly exploited that weakness and now Woolworths has to spend billions cutting prices to shift the perception that it is too expensive.
At the same time, it has a capital hungry, loss-making hardware misadventure (Masters), a declining general items business (Big W) and perhaps most stunningly, no replacement for the outgoing CEO as yet, and, therefore, no solid public strategy for how to fix these problems going forward.
Would you get on a boat with several leaks, no captain and no map to the final destination? That's what investors who buy Woolworths now are doing, and that does not seem like a rational decision to invest based on facts.
Making money by investing is not easy, but perhaps not losing money by avoiding the stocks likely to decline in value in the short term is a little simpler. All three of these businesses are profitable, and likely to become good buys some time in the future – but buying them now will put your capital at risk.
