The stock market continues to march higher, but not all investors necessarily consider that a good thing. All-time greats from Carl Icahn to Warren Buffett have questioned whether the historic rise, or the difficulty of finding value stocks in today's expensive environment, will end soon. They certainly have a point.
At a time when investors need to dig deep to ignore emotional cues and stick to their long-term plan, or put in the extra effort to find that hidden gem, they cannot afford costly mistakes -- such as hanging onto a stock that's set to drop. That's why I think there's good reason to ditch specialty chemical manufacturer Chemours Company (NYSE: CC), oilfield products supplier Flotek Industries (NYSE: FTK), and whiskey specialist MGP Ingredients (NASDAQ: MGPI).
Continue Reading Below
A socially irresponsible investment
There's no denying that Chemours is running an efficient operation right now. Its titanium and fluoroproducts businesses are booming. They alone have resulted in a 114% increase in EPS in the first nine months of 2017 compared with the year-ago period. A steady increase in selling prices will have that effect. However, I think there's a major cloud hanging over the stock.
Shares have more than doubled in the past year, for two reasons. First, Chemours settled a long-standing legal dispute over the release of a toxic chemical previously used in the manufacturing process of its fluoroproducts. That relieved Wall Street's concerns and removed uncertainty. Second, a global recovery in selling prices of titanium dioxide has boosted performance throughout the year. The improvement is genuine and could continue to deliver gains, but the company may be headed for additional uncertainty regarding pollution.
That's because PFOA, the toxic chemical at the center of the previously settled legal battle, was replaced with something called GenX, which appears to be just as toxic to human health. Worse for investors, the state of North Carolina isn't taking any chances and is getting serious with Chemours before a major public health crisis has the chance to unfold. The company is currently facing five separate lawsuits regarding the discharge of GenX, is being forced to provide bottled water to at least 85 households found to have tainted wells, and may even be investigated by the state's Bureau of Investigation for criminal charges.
Simply put, I wouldn't feel comfortable owning Chemours stock right now, and I don't think too many other investors would feel that it's a socially responsible investment, either.
Don't wait for this stock to ripen
Flotek Industries stock has recently sunk to lows last seen in 2011. That's mostly due to one culprit: oranges. Yes, as in the fruit. It may seem ridiculous at first, but investors need to consider the long-term risks.
The company's drilling products and specialty ingredients are derived from citrus oil, which is predominantly sourced from America's orange crop. However, years of citrus greening disease have devastated the country's output, while the recent hurricane season wiped out half of all citrus acres. The result: significantly reduced supply, significantly higher prices, and virtually no reasonable alternative for sourcing the inputs that Flotek Industries has staked its product portfolio upon.
Worst yet, the problem is largely out of the company's hands. Without significantly pivoting on its established product portfolio -- a costly move that would take years -- there doesn't appear to be much reason for near-term optimism. Even if the nation's citrus crop rebounds from the effects of this year's hurricane season, citrus greening disease promises to continually erode output over time. Investors should steer clear of Flotek Industries stock.
A multi-bagger set to drop
Although the stock continues to climb, I don't think MGP Ingredients can continue to hold its remarkable gains. The contract distiller has risen from an $80 million market cap five years ago to a $1.2 billion valuation today -- the definition of a hidden gem. The growth is certainly impressive, but the 17-bagger stock hasn't quite earned that valuation.
In the past three years, MGP Ingredients has enjoyed a 374% increase in market cap despite just a 66% increase in annual EPS. That simply isn't sustainable. Sure, the company has a genuine business and a major vote of confidence from blue-chip customer Diageo, but that alone isn't worth the stock's premium. Besides, much larger fuel ethanol companies are beginning to pivot spare capacity into the higher-margin premium beverage space -- and they have an order of magnitude more capital to deploy.
That means there's a new crop of competition about to make growth that much more difficult for MGP Ingredients. The distiller can still grow for the foreseeable future, but there won't be much room for error. Given the astronomical rise in the past three years and its excessive valuation, it seems reasonable that investors will abandon the stock once the growth story begins to falter.
What does it mean for investors?
There's no denying that the broader stock market is historically expensive. While that doesn't mean investors need to run away in fear, it does hint that they need to continue to focus on only the strongest businesses with a long-term mindset. However, I think there are strong reasons that Chemours, Flotek Industries, and MGP Ingredients are three stocks set to drop. Investors should proceed with caution.
10 stocks we like better than Flotek IndustriesWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Flotek Industries wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of November 6, 2017