5 Stocks You Can Sell Right Now

A little more than two months ago, I decided I would step out of the box and stop living by other Wall Street analysts' rules. Instead, I chose to create my own formula that would look at book value, price-to-sales, and price-to-cash-flow to determine the market's most overvalued stocks. You can learn more about the criteria and the thought process that went into my one-of-a-kind formula, dubbed TMFULOI, by clicking here.

With just over two months under my belt since my first selections, the results can be described as nothing short of a resounding success. Here's how the five most overvalued stocks have performed since that first article:

Company

Performance Since April 3, 2012

Mitek Systems (71.3%)
Baidu (Nasdaq: BIDU  ) (17.5%)
LinkedIn (NYSE: LNKD  ) (6.3%)
Yandex (28.9%)
MercadoLibre (28.6%)

Source: Yahoo! Finance, author's calculations.

No doubt about it; I may be on to something here! Mitek is dealing with patent issues that have cost it much of its market value in the wake of that article. The remaining stocks, minus LinkedIn, which has held up relatively well, have fallen considerably more than the overall market indexes.

With that said, I'm going to give this another try and see how useful my TMFULOI valuation metric might be on a new round of overvalued companies. This time I'm also going to make an exception and allow one biotechnology stock to infiltrate the ranks, as it does have a regularly sold drug (i.e., it won't skew the rankings).

Admittedly, with the market having corrected, the pickings were much slimmer than last time, but I still managed to wrangle five companies that fit the bill and are markedly overvalued. You'll see some familiar names, but we also have some new additions:

Company

Price/Book

Price/Sales

Price/Cash Flow

TMFULOI

LinkedIn 15.2 18.6 67.3 101.1
Alexion Pharmaceuticals (Nasdaq: ALXN  ) 14.2 20.7 57.8 92.7
Baidu 15.6 16.5 33 65.1
Gold Resources (AMEX: GORO  ) 14.3 11.1 29.3 54.7
SolarWinds (NYSE: SWI  ) 11.3 15.5 27.5 54.3

Sources: Motley Fool CAPS Screener, Morningstar, author's calculations. Data as of June 8, 2012.

The first thing you'll notice is that it's not all tech companies this time. We have biotech and mining, as well as higher-growth tech stocks represented this time.

LinkedIn
LinkedIn makes its second appearance on this list, vaulting to the No. 1 spot -- although down in total TMFULOI points from its previous ranking. Despite the slight drop in price to cash flow, LinkedIn still seems like fool's gold to me. Premium subscriptions, which are the key to driving LinkedIn's margins higher, rose 91%, but as a percentage of total revenue, premium subscriptions fell to 20% from 21% in the year earlier. I also wouldn't overlook the fact that LinkedIn's focus on connecting business professionals is highly dependent on the economy getting better. A weak jobs report in May could take some of the wind out of LinkedIn's sails.

Alexion Pharmaceuticals
Normally, I don't consider biotechnology stocks because their revenue generation is often erratic. That isn't the case for Alexion, which is currently sporting a market value north of $17 billion despite having only one drug approved by the Food and Drug Administration. Soliris, which treats paroxysmal nocturnal hemoglobinuria (a cause of anemia), brought in nearly $1.1 billion in annual sales last year. My concern is that its lack of pipeline diversity could be its downfall. The company's five other studies currently under way also involve the combined use of Soliris, giving it few avenues to succeed if Soliris doesn't find success in alternate trials. Remember, drug patents don't last forever, and neither will Alexion's valuation, I predict.

Baidu
Baidu has made serious strides to remove itself from being listed, using my TMFULOI metric, as one of the market's most expensive stocks. Its TMFULOI score has been cut nearly in half in just two months, thanks, in part, to another strong quarter of sales and cash flow growth highlighted by a 75% increase in total revenue. However, I remain skeptical of Baidu's valuation considering that China's growth is still slowing, which could weigh on advertising spending, and the fact that expenses keep rising in line with revenue. I understand the need to expand its reach, but its additional costs could become a burden when its growth rate slows. Its valuation is getting more reasonable, but it still is a far cry from a buy in my opinion.

Gold Resources
Although I'm bullish on the outlook for gold and silver miners, Gold Resources joins a small handful of miners that I'd just as soon pass on. The company spent a long time building out its mines in Mexico and only last year enjoyed its first year of production. Mining costs have remained exceptionally low, allowing Gold Resources to join many other mining companies in paying out a quarterly dividend. While it might seem like the perfect company, I doubt it can keep its mining costs this low for any extended period of time, and I'm concerned its valuation will take a hit if compared side-by-side with peers Newmont Mining and Silver Wheaton, which boast markedly lower forward earnings multiples and price-to-cash-flow ratios. It isn't the most obvious sell of these five stocks, but it nonetheless is a stock I wouldn't want to own.

SolarWinds
SolarWinds holds the rare distinction of being the only company listed in April whose TMFULOI score has actually gone higher! What's making this IT software producer more expensive? As the Fool's Rex Moore outlines, it's the company's disruptive software, which allows ease of use for its clients and gives them an edge over their competitors. However, I feel it'd be ignorant to assume its much larger competitors won't adapt their software to a similar platform or simply use their huge marketing budget to squash SolarWinds in its tracks. I predict that at some point in the near future, SolarWinds' growth will slow from its traditional 30% growth rate and expose its 30-plus forward P/E and price-to-cash-flow of 27.6 to the elements of a fickle and unforgiving market.

Foolish roundup
There you have it: round two of the five most overvalued stocks according to my handy-dandy TMFULOI metric. We'll check back in a few weeks to see if there really is something to this metric, or if the last two months were just a fluke. I'll also be adding what few companies aren't already in my CAPS portfolio as underperforms to show my conviction that these valuations simply can't hold.

If making things up as you go along isn't your thing, then the Motley Fool's latest special report, which highlights our chief investment officer's "Top Stock for 2012," might be right up your alley. Find out for free which stock has him buzzing with excitement.

Feel free to keep track of my progress by adding these stocks to your free and personalized watchlist so you can keep track of the companies that matter to you!

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of LinkedIn, Baidu, and MercadoLibre. Motley Fool newsletter services have recommended buying shares of LinkedIn, Baidu, and MercadoLibre. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's just the facts, ma'am.


Read/Post Comments (5) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 12, 2012, at 5:15 PM, Rk703 wrote:

    Are comments that disagree with the authors assumptions, etc.. purged or not posted. Right or wrong they deserve to be displayed... if for nothing else than to be refuted. Otherwise how can any articles be taken seriously.

  • Report this Comment On June 13, 2012, at 2:32 AM, Seamaster7734 wrote:

    Sean,

    A few points.

    First, it's Gold Resource, not Gold Resources.

    Second, their dividend is paid monthly, not quarterly.

    These might seem like nits, but when you miss obvious and easily obtained basic facts, it makes one wonder how thorough an analysis we have here

    You say it took a long time to get the mine up and going, which is just wrong. Detour touts "record" time from discovery to production at 6 years. You guys used to tout Rubicon, who says they're going from discovery to production in 5 years. Gold Resource went from discovery to production in about 2.5 years. In the mining world, that's no time at all.

    Let's say it took a "long" time to get the mine up and running. So what? Anything can hold up mine construction, especially permitting, and as long as it doesn't increase mine construction costs, what counts is what happens after the mine opens.

    Finally, you "doubt it can keep its mining costs this low for any extended period of time". This is a conclusion without any analysis. You offer nothing to back this up.

    It makes more sense to say Gold Resource can lower its mining costs for an extended period of time. Why, you ask? Because ore grades often get larger and richer at depth. The by-product credits from copper, lead and zinc that make the cost per ounce so low are likely to drive the cost of gold equivalent ounces lower, not higher.

    I have a few criticisms about Gold Resource, but nothing you addressed here.

  • Report this Comment On June 13, 2012, at 9:10 AM, TMFBreakerRob wrote:

    A couple more things to consider:

    * Some companies are "asset light" and don't have much book value, yet they still make lots of money. This isn't a negative, but your methodology penalizes such companies.

    * Quickly growing companies often don't have a lot of cash flow, yet they're building the foundation for a much larger company in the future. Your methodology penalizes these companies as well.

    I'm not suggesting that simple screens don't have value, but you need to be careful you're not screening out the best companies of the future.

  • Report this Comment On June 13, 2012, at 11:35 AM, TrackUltraLong wrote:

    Rob,

    Duly noted and I did my best to take book value into consideration by banishing certain sectors from my rankings.

    The thesis here is that if these companies are growing quickly enough, their TMFULOI score should realistically fall as earnings power rises more rapidly than valuation. My simplistic model is looking to catch companies that are likely growing very fast, but whose valuation may be outpacing even that rapid growth. On a positive note, only 1 of the original 9 just two months ago saw their score rise which, to me, means stocks are getting more reasonably valued.

    I'll need a few more screens every 6-8 weeks to see if this was a fluke or has genuine value, but I generally like the odds all things considered.

    Sean

  • Report this Comment On June 14, 2012, at 11:02 AM, vaderblue wrote:

    I review my picks using financial data, historical data, and yes the income statement. Looking at the retained earnings and finding cash available to the stockholder is essential and leverage cash.

    Instiutional buying is signal. Just because a stock has a bad quarter does not mean it's time to sell. Don't be so hasty. High cost of sales can be controlled and why is there a high cost of sales. The purpose can be explained. Eg:

    Cost of Bread to produce. Rising flower prices or yeast may drive up the price when producing the finished product and on a large quantity to sell.

    The orders in most cases are set on historical costs and now this changes predicated on rising yeast or flower prices but what goes around comes around and a good investor will hold that position looking for better quarters ahead and don't be so hasty in minimizing your losses when in turn you will have a profit. Patience is a virtue if you are invested in a strong company Speculative stocks are what they are. It's gambling.

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