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Spain appears to be the new Greece, with 10-year bond rates skirting the dangerously high 6% level, but here's a surprise: The market seems to be mostly ignoring it. For optimists, these rallies may seem like a dream come true. For skeptics like me, they're opportunities to see whether these companies have earned their current valuations.
Keep in mind that some companies deserve their current valuations. Shareholders are happily hitching their wagons to Tractor Supply (Nasdaq: TSCO ) . The retailer of everything from outdoor equipment to pet supplies has benefited from a record year of high prices for farmers in 2011 and a consistently growing pet industry.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Some companies naturally trade at cheap valuations while others never seem to come out of the clouds. Ariba (Nasdaq: ARBA ) , a provider of software and services that helps businesses manage their purchases, is one such company that (even after the Internet bubble) has yet to return to Earth.
Only recently profitable and with few rivals, Ariba has struggled to grow. The company has logged just 8.5% annual revenue growth over the past five years despite trading at 48 times cash flow and 32 times forward earnings.
Even more concerning than Ariba's valuation are its rapidly rising expenses, which more than cancelled out a 39% rise in revenue during the first-quarter. Overall expenses rose by 58%, and gross margin sank 460 basis points from the year-ago period. To me, this appears to be more of the same from Ariba and its free-spending management team. I'd suggest making Ariba earn this valuation before you buy the stock.
Don't gamble on this stock
I recently expressed my opinion that the gambling turnaround in the U.S. is still up in the air. Therefore, Bally Technologies (NYSE: BYI ) , a software and gaming provider to casinos, appears to be a good sell candidate after nearly doubling since early October.
Bally is coming off of three straight years of revenue contraction despite healthy profits, but that hasn't done anything to save the company's valuation from shooting through the roof. At 26 times cash flow and nine times book value, Bally is pressing up against the high end of its valuation bounds over the past decade.
There are other worrisome aspects to this company. I had to go all the way back to May of last year to find the last time a Bally insider purchased stock. Also, because of the capital-intensive nature of its business, Bally's debt-to-equity of 224% is slightly higher than the industry average. Between the seemingly endless product cycle and the ebb-and-flow nature of the gambling business, this is not a company I'd deem an intriguing value at these levels.
Sweet dreams or a nightmare?
Would someone like to remind Mattress Firm (Nasdaq: MFRM ) that it sells mattresses, not cloud-based enterprise software or iPads? You wouldn't know it, since the stock has more than doubled since it debuted in November, which has left its shareholders three sheets to the wind with enthusiasm.
But seriously... mattresses? I can somewhat relate to the idea that consumer spending on discretional items is beginning to tick higher, and I do see the bullishness being expressed by Mattress Firm's CEO Stephen Stagnar, who wants to open 100 stores each year until his chain has 2,500 across the United States. But mattresses?
I simply don't see mattresses being as high-growth as Wall Street or Mr. Stagnar seem to be predicting, and I certainly expect the law of big numbers to catch up with Mattress Firm sooner than later. I made the case a few months ago in favor of mattress producer Sealy (NYSE: ZZ ) , which trades at just six times cash flow. I think it makes a world more sense than ponying (or should I say sheeping?) up 22 times cash flow or a whopping 770-plus times book value for Mattress Firm. I'd personally sleep a whole lot better not owning this.
Even though it's always about valuation, this week should be a wake-up call for investors in these three stocks. Ariba at 48 times cash flow, Bally's falling revenue, and Mattress Firm's unsustainable growth rates for a discretionary product are what I consider prime examples of investors in need of a wake-up call. I'm so confident in my three calls that I plan to make a CAPScall of underperform on each one. The question is: Would you do the same?
Share your thoughts in the comments section below, and consider using the following links to add these three stocks to your free and personalized watchlist so you can keep track of the latest news on each company. And to avoid investing in stocks like these, consider getting a copy of our special report, "The Motley Fool's Top Stock for 2012." In it, our chief investment officer details a play he dubbed the "Costco of Latin America." Best of all, this report is free for a limited time, so don't miss out!