The Rally In These Stocks Is Almost Over — Get Out Before It’s Too Late
For true long-term investors, the intended holding period for a stock is typically measured in years, and the decision to buy it is based solely on that company’s long-term prospects.
But every now and then, a short-term factor takes hold and forces an investor to become a trader. Refusing to take on that role, even if only temporarily, can mean missed opportunities.
Like it or not, anybody who’s currently holding a position in Kellogg (NYSE: K), General Mills (NYSE: GIS), or Flowers Foods (NYSE: FLO) is a trader. How so?
Because these food stocks and their peers have rallied considerably since the latter part of last year — so much so, in fact, that they’re all at considerable risk of a pullback. Shareholders will have to make a decision soon, too, since the underlying reason for the rally is already starting to unwind.
If you’re looking for the reason these cereal and bread producers saw their stocks rally an average of nearly 40% in less than a year, you don’t have to look any further than an intermediate-term price chart of wheat.#-ad_banner-#
After soaring from $6.13 per bushel to a peak of $9.44 (a 54% spike) in a five-week span last summer, shareholders were understandably nervous. After all, if grain costs spin out of control, it eats into profit margins for those companies that need them to remain in business.
Wheat prices — and all grain prices, for that matter — didn’t continue to skyrocket. Instead, investors were relieved to see wheat prices slide to a low of $6.59 per bushel by April. Relieved investors celebrated by taking on stakes in General Mills, Kellogg and other names in the cereal and bread industry.
There’s just one problem with the reasoning. If wheat and other grains behave now as they have for the past several years, wheat prices are apt to rise in the very near future. In fact, wheat prices may have already begun that rebound.
Red Flags Are Waving
Wheat prices are notoriously volatile — but not entirely unpredictable. Since 2010, the two slow pullbacks have each been followed by sharp surges. Tracing the lows from those prior bottoms just happens to line up with the low we saw from wheat prices just six weeks ago.
Although wheat and other grains have yet to spike as they did in the middle of last year and also in 2010, if the pattern and support line are any clue, such a move is around the corner.
Even if wheat doesn’t soar, it’s still clear there’s little downside left to dole out. Therefore, there’s little foreseeable upside left for these stocks.
It’s not even the matter of a trend merely coming to a close, however.
Although grain prices have admittedly fallen quite a bit since July of last year, stocks of wheat-using companies are now well into all-time high territory. The market for some reason has become euphoric about the benefits of cheap wheat this time around, pushing them to alarmingly high price-to-earning (P/E) ratio levels.
For example, shares of Flower Foods are trading at 33.2 times their trailing income. That’s the loftiest valuation we’ve seen in years. At 24.1 times trailing earnings, Kellogg shares are as expensive as they’ve been in more than a decade. General Mills is priced at a more palatable P/E ratio of 18.3, but that’s still the most expensive price we’ve seen General Mills shares reach since 2002.
And remember, margins are unlikely to widen further — and wheat prices are already starting to perk up again.
That’s what makes these stocks so vulnerable right now. Between excessive valuations and rising wheat prices, the euphoria could evaporate in an instant and send these stocks lower in a hurry.
Risks to consider: Though the impact was likely already built into grain prices by the time the announcement was made, the U.S. Agriculture Department said on Friday that we’d see the largest crop yields on wheat, corn, rice and oilseed ever on a global basis this year. Most of that overall growth was led by the 23% increase in corn output, but with all major crops expected to show higher production, pressure was put on wheat and other grain prices.
Action to take –> None of this is to suggest that wheat-intensive stocks like Kellogg, General Mills or Flowers Foods are poor companies. But their stocks don’t accurately reflect their current underlying value or prospects. All three stocks, as well as most of their peers, could suffer a pullback of 20% or more, once the scales tip the other way.
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