Whether or not "sell in May and walk away" will play out this year remains to be seen as the S&P 500 rallied to a new all-time record high to begin this week. For skeptics like me, that's an opportunity to see whether companies have earned their current valuations.
Keep in mind that some companies deserve their current valuations. Take Waste Management (NYSE:WM), for instance, which has rallied ever since reporting its first-quarter results last week. The company's internal revenue growth from yield for its collection and disposal operations came in at a two-year high, 1.4%, and the company modestly improved its adjusted year-over-year EPS. Trash disposal and recycling are necessity businesses and make Waste Management a solid long-term buy.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Time to make the switch
If I could name a sector that I'd certainly tread lightly around considering that consumers are tightening their wallets, it would be the casino sector. Casino companies rely on loose wallets and vacations to drive profits. This is why I feel it could be the time to say goodbye to casino and race track operator Pinnacle Entertainment (NASDAQ:PNK) near its 52-week high.
Pinnacle's first-quarter report, announced yesterday, wasn't as bad as many had projected, with the company's loss smaller than expected despite higher taxes and delayed tax refunds biting into consumers' pockets. However, what bothers me most about smaller casino operators like Pinnacle Entertainment is that they are completely dependent on consumer spending in the U.S. -- and it has been years since the gaming industry in the U.S. has shown any signs of life.
Instead of purchasing Pinnacle, which carries a debt-to-equity in excess of 300%, doesn't pay a dividend, and is valued at 21 times forward earnings despite a revenue growth rate of just 7%, I'd recommend swapping it out for Las Vegas Sands (NYSE:LVS). With Las Vegas Sands, you get U.S. exposure, but you also get rapidly growing exposure to Macau, where Sands' casino and resorts are catering to a wide swath of income levels. You also get a 2.5% yield with Las Vegas Sands and a lower forward P/E ratio with a much quicker revenue growth rate.
Insurance I wouldn't touch
Let me preface this by saying that I agree with most analyst assessments that the mortgage insurance sector is improving. Legacy defaults from the financial crisis are slowly working their way off many insurers' books and liquidity for many mortgage insurers is improving. However, I can't really say the same for MGIC Investment, which I added to my short-list a few weeks ago. This week, I'm also going to add its peer Radian Group (NYSE:RDN) to that list after an abysmal first-quarter report.
For the quarter, which was reported yesterday, Radian saw its losses widen to a whopping $1.30 per share as a fair value derivative change walloped reduced earnings by $173.3 million. Radian did write $10.9 billion in new mortgage insurance and improved its risk-to-capital ratio to 18.6, but it still can't turn an annual profit. I firmly believe that Wall Street analysts were a bit premature in their call that the mortgage insurance sector is healthy -- especially with regard to MGIC and Radian, which have both had incredible runs yet continue to report steady losses.
Until I see steady profits and significantly lower risk-to-capital ratios, I'm going to avoid the mortgage insurance sector like the plague.
The waiting game
The tables are clearly stacked against small biotech companies developing cancer drugs. History has shown that few (if any) have successfully had the Food and Drug Administration approve a late-stage cancer drug. While mid-stage trials of Galena Biopharma's (NASDAQ:GALE) HER2-targeting breast cancer vaccine have been promising thus far, the chances of an approval seem a long way off.
In phase 1/2 trials the recurrence rate was reduced to just 5.6% in the NeuVax arm compared to a 25.9% recurrence rate in the control arm after a 60-month period. However, the split patient pool for these vaccines was relatively small (187 people) and it will take an additional three years to determine whether NeuVax meets its primary endpoint of disease-free survival once the phase 3 study is full. Including an FDA panel review and FDA PDUFA decision, we could be looking at 2017 before NeuVax even has the slightest chance at hitting the market.
Also, nearly Galena's entire pipeline is made up of some trial involving NeuVax, so a failure here could be a potentially big blow to shareholder confidence. This is a situation where I'd like to believe NeuVax could succeed, but there are viable reasons -- and a three-year wait -- to believe that this valuation is far from deserved.
This week's theme is all about keeping investors' expectations in check. Pinnacle's reliance on the domestic gambling industry, Radian's mounting losses from its legacy mortgage loans, and having history stacked against Galena make all three potential underperformers.
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.
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