There are a number of FTSE 100 stocks I think could disappoint investors in 2020. Among them are AstraZeneca (LSE: AZN), St. James’s Place (LSE: STJ) and Scottish Mortgage Investment Trust (LSE: SMT). Here’s why I’m avoiding these three.
Dubious core strength
AstraZeneca’s management has maintained the core earnings per share (EPS) guidance it gave at the start of the year of $3.50-$3.70 for 2019. At the midpoint and current exchange rates, this gives a price-to-earnings (P/E) ratio of 26.5 at a share price of 7,300p.
This is a huge premium to Footsie pharma peers GlaxoSmithKline and Hikma Pharmaceuticals, which trade at P/Es of 14.4 and 17.7 respectively. Furthermore, I’d argue AZN’s core EPS, on which the 26.5 P/E is based, grossly overstates its real core earnings, and that the true P/E is nearer a jaw-dropping 40.
This is because I exclude one-off profits from the divestment of non-core assets, which can’t go on forever but which AZN books as core operating profit. I also include legal costs (a routine expense in operating a big pharma company), which AZN excludes. AZN looks overvalued to me on its own core EPS measure, but grossly overvalued on what I consider its true core earnings.
Iffy business model
I’m avoiding wealth manager St. James’s Place on a view that it’s not only overvalued, but also has an iffy business model, and will have to change, with profit-margin-sapping consequences.
At a share price of around 1,100p, STJ’s P/E is 32.4 on forecast EPS of 34p for 2019. This earnings multiple is far too high, in my opinion. Furthermore, a valuation of more than 3% of funds under management (FUM) has proved a trusty indicator of overvaluation, in my experience. With a market capitalisation of £5.88bn, and FUM of £112.82bn, STJ is valued at 5.2% of FUM.
The company’s management fees and exit fees are excessive, in my view. Investors haven’t worried too much about this, seeing their portfolios increase in value over the last 10 years of rising markets, but are likely to pay a lot more attention in a downturn. Furthermore, with investors generally becoming a lot savvier about the corrosive effect of fees on returns, I think STJ will ultimately have to reset its margins.
Bonkers
It’s a peculiar and persistent feature of the UK stock market that some investment trust or another will rise from the FTSE 250 to the FTSE 100. However, no trust in history has gained sufficient critical mass to maintain its position in the top index.
Scottish Mortgage is the current representative in the FTSE 100. It’s achieved its status by a combination of high returns (471% over the last 10 years) and increasing popularity with investors (taking its shares to a premium to net asset value (NAV)).
The company has surfed on the outperformance of the US market and tech sector, holding a number of the so-called FAANG stocks, and the likes of Illumina and Tesla. The managers of the trust have borrowed money to gear returns (gearing is currently 9%), and remain optimistic on the outlook.
Personally, I think the valuations of many of the underlying holdings are bonkers. I fear a de-rating, SMT’s NAV dropping, gearing working negatively, and the shares moving to a wide discount to NAV. If so, SMT will become another in the long history of investment trusts failing to maintain a place in the FTSE 100.